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Finance & Accounting
Pages 5 (1255 words)
1. Absolute Advantage and Comparative Advantage: Two-country and Two-product Model Absolute advantage and comparative advantage are the basic trade concepts to know the whole trade process. Absolute advantage concept was developed by Adam Smith, which is defined as a production condition in which a country, group, or individual “can produce and sell a product at a lower costs than any other.
U.S. Source: Peng, 2011, p.151 The figure shows that China has produced 20,000 tons of wheat and 10 aircraft while the U.S. has produced 5,000 tons of wheat and 20 aircraft. Therefore, China has an absolute advantage over the U.S. in producing wheat considering that this activity is labor intensive, and China is a labor abundant country (Claro, 2009; Zhu, 2004). In fact, it only takes 20 resources for China to produce 1,000 tons of wheat compared to the 80 resources from the U.S. Conversely, the U.S. has an absolute advantage in making aircrafts; in fact, China needs 40 resources (labor time/unit) to produce 1 aircraft while the U.S. only needs 20 resources. According to Bailey & Rai (2000, p.146), the making of aircrafts is a capital-intensive activity wherein the U.S. is more capable of considering that it is a capital intensive county (Weeks, 2001). Based on this two-country and two-product model, it is suggested that China is to concentrate in producing wheat while the U.S. is to aircraft; hence, both of them would be benefited by specialization. Comparative advantage was introduced by David Ricardo and defined as “the ability to produce a good at a lower opportunity cost than another producer” (Mankiw, 2012, p.55). ...
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