Dear k9queen-ga,
Good day!
The theory of comparative advantage states that X has comparative
advantage over Y in producing Z if X’s opportunity cost (the benefit
lost by not doing the alternative) of producing Z is less than the
opportunity cost for Y. The British economist David Ricardo developed
this theory when he realised that the theory of absolute advantage (as
propounded by Adam Smith) was a limited case of a more general theory.
Before I answer your question, I analyze the situtation in the next
few paragraphs. I then choose the options and give a brief
explanations for the choices.
Analyses
========
Let us examine the problem closely. The followng table formalises the
problem at hand:
Producer Doors Cabinets
A 3 15
B 1 3
Notes:
1. Notice that A is 3 (and 5) times more productive than C in
production of Doors (and Cabinets). Thus, A has absolute advantage
over B in production of both the items.
2. The opportunity costs of doors for cabinets are 1 for 5 for A and 1
for 3 for B. By not producing one unit of door, A can produce 5 units
of cabinets. In B the opportunity cost ratio is 1 for 3 (1/3), i.e.,
1 door exchanges for 3 cabinets.
3. Assuming constant opportunity costs, Ricardo suggested that the
ratios would always remain the same: 1/5 and 1/3.
4. To determine comparative advantage, notice that if A exchanges 1
door for 5 cabinets, it also would exchange 3 doors for 15 cabinets.
Similarly, if B excahanges 1 door for 3 cabinets, it also would
exchange 5 doors for 15 cabinets. This gives two comparable
opportunity cost ratios that have a common denominator: A, 3/15 and B,
5/15.
5. Consider the gains from specialization. If A tries to produce
doors, it must sacrifice 15 cabinets to produce 3 doors. If B tries
to produce doors, it sacrifices 15 cabinets to produce 5 doors. This
implies that we should encourage B to produce doors because it gets 5
doors if it does not produce 15 cabinets; A would only get 3 doors if
it does not produce 15 cabinets.
6. On the other hand, A's cost of cabinets is less. A sacrifices only
3 doors in order to produce 15 units of cabinets and B would have to
sacrifice 5 doors in order to produce 15 cabinets. It costs less to
produce cabinets in A (in terms of sacrifice of doors).
7. Gains. A specializes in cabinets and B in doors. They come to the
bargaining table. A wants at least 3 doors for its 15 cabinets (this
is the opportunity cost ratio before specialization). B will give up
to 5 doors to obtain 15 cabinets (this is the opportunity cost ratio
before specialization). It looks like a deal can be made. In fact
any final terms of trade between 3/15 and 5/15 will provide gains to
each party. Suppose bargaining results in a 4/15 ratio (this was
arbitrarily chosen as one ratio between 3/15 and 5/15. A used to give
up 15 cabinets to produce 3 doors. Now A specializes in cabinets and
trades 15 cabinets for 4 doors. B used to give up production of 5
doors in order to produce 15 cabinets. Now B specializes in doors and
trades 4 doors to obtain 15 cabinets. Both parties have gained but
they have not gained equally. It would be unusual for them to gain
equally but it is possible.
8. As long as the opportunity cost ratios (3/15 and 5/15) are
different, there will be gains. Notice that A had an absolute
advantage in producing both items but it was able to gain from trade.
B also gained although there was an absolute disadvantage in
producing both items. This should not be too surprising to you. If
you were a brain surgeon but also the best computer expert in town,
would you do your own computer work? Of course not. You would hire
it out and do what you do comparatively better, brain surgery. You
could make much more that way. It is the same principle in
international specialization as in domestic specialization of labor.
Problems
========
18. a) Producer A would reject but B would accept
1/6 is equivalent to 5/30. => A will get only get 5 doors instead
of 6 doors ((3/15)*2 = 6/30) if he trades the cabinets. On the other
hand, B will trade 5 doors (instead of 10) and will get 30 cabinets.
19. b) Producer B would reject but A would accept
1/1 is equivalent to 30/30. => A will get get 30 doors instead of
6 doors ((3/15)*2 = 6/30) if he trades the cabinets. On the other
hand, B will trade 30 doors (instead of 10) and will get 30 cabinets.
20. b) Producer B would reject but A would accept
1/2 is equivalent to 15/30. => A will get get 15 doors instead of
6 doors ((3/15)*2 = 6/30) if he trades the cabinets. On the other
hand, B will trade 15 doors (instead of 10) and will get 30 cabinets.
Hope this answer is satisfactory to you!
Thanks & regards,
reeteshv-ga
Additional Links:
A very good overview of the theory of comparative advantage is
available here:
http://internationalecon.com/v1.0/ch40/40c000.html
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