THE PRINCIPLE OF COMPARATIVE (COST) ADVANTAGE
The principle or theory of comparative cost advantage was propounded by David Ricardo in the 19th Century.
The theory or principle states that countries derive mutual benefit from trade when they specialize in the production of those commodities in which they have greatest comparative cost advantage over others and exchange them for other commodities in which they have comparative cost disadvantage.
A country should produce for export those commodities it can produce more cheaply and import those which it can only produce at higher costs. In discussing the principle, absolute advantage is not dealt with, rather, comparative advantage is made use of.
A country has a comparative advantage over others in the production of a commodity in which it has the lowest opportunity cost than others. Therefore, it is the real cost of producing a commodity (in terms of other commodities foregone) that is taken into consideration.
Assumptions of the principle of comparative cost advantage.
This principle or theory is based on the following assumptions:
- There are only two countries.
- Only two item are produced with the available resources.
- There is free flow and mobility of factors of production.
- There is no transportation.
- Constant costs prevail
- Technology is constant.
- Labour is the only factor of production. In relation to the above assumptions,
Nigeria and the United States of America (USA) for example, are producing and consuming rice and wheat. The pre-specialization production position is shown in schedule A below:
Schedule B is an estimated opportunity cost of producing the two commodities by the two nations.
|Nigeria||50 – 1 100 2 i.e. I bag of rice = ½ Bag of wheat||100 = 2 i.e. 50 1 I bag of wheat bags of rice|
|USA||50 – 1 100 2 i.e. I bag of rice = ½ Bag of wheat||100 = 2 i.e. 50 1 I bag of wheat bags of rice|
By the law of comparative cost advantage, Nigeria should specialize in the production of rice while USA should specialize in the production of wheat.
Total world output after specialization i.e. Nigeria=Rice, USA=Wheat using all available resources.
Increase in output of both rice and wheat by 50 bags each
Advantages or gains of comparative cost advantages
- There is an increase in total world production.
- There is better and effective utilization of resources.
- There is increased consumption of commodities e.g. rice and wheat.
- There are innovations, resources- fullness and improved technology.
- There is increase inter-dependence between nations of the world.
- There is reduction in the prices of goods due to mass production.
Limitations of the comparative cost advantage
- There are more than two commodities in the world. The presence of many commodities makes the principle impracticable.
- There are also more than two countries in the world.
- All countries of the world do not have equal efficiency of labour not to talk of other factors of production.
- There is no free transport between the countries in the world.
- There are other factors of production other than labour e.g. capital, land and entrepreneur.
- All countries of the world can never have equal availability of labour.
- The cost of production in the world can never be constant.
- Trade imbalance between countries of the world also makes the principle unworkable.
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