Comparative Cost Contd Suppose

Comparative Cost Contd Suppose

Comparative Cost (contd)Suppose a given quantity of resources could produce the following amounts of x and y in the two countries:

Comparative Cost (contd)Specialization obviously pays in (1)since larger amounts of both z and are produced. It also pays in (2) if it can be shown that the loss of by is more than compensated for by the gain of 25%. That it does is confirmed by comparing the ratios of production costs in A and B: in A 25x has the value of 2oy; in B 25x has the value of 30/. But specialization does not pay in example (3) despite A's absolute advantage, for 25% has the value of 2oy in both, so that there is no net gain from specialization: the gain in x no more than compensates for the loss in y. Thus whether or not there is an absolute cost difference does not matter. What is important is that there must be a comparative cost difference, and, where there is none, as in example (3), there is no gain from specialization and exchange.

The doctrine can be restated in this form: other things being equal, specialization and exchange according to the principle of comparative advantage will pay only if the ratio between production costs differs in the two countries. The qualification is necessary since in real life specialization itself may cause cost ratios to change, increasing or reducing the gain from exchange. Also if the goods produced in each country are not completely identical, trade may be worthwhile even though relative cost ratios are the same. With these qualifications the principle can be extended to deal with more complex examples of many countries and many commodities.

The general principle of comparative cost provides an economic explanation of specialization, but by itself it is not a sufficient argument for free trade between nations, since it makes no allowance for the effects of free trade where economies are growing or where factors are immobile within one or both countries or where there is monopoly power. But it embodies fundamental economic truth.

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