Question

If you were recommending economic policy to a developing low-income country, at what point would you recommend that it follow a policy of comparative-advantage trade, and at what point would you recommend sacrifice a certain amount of efficiency in the use of its resources in order to achieve more growth?

Answer 1

Comparative advantage is the ability to produce a good at a lower opportunity cost (the total amount that one must give up in order to get something) than the country one trades with. As long as comparative advantage exist, trade is beneficial. It is dependent upon different resource endowments (land, capital, labor) and technological advantages.When a country has a comparative advantage in the production of a good, it means that it can produce this good at a lower opportunity cost than its trading partner. Then the country will specialize in the production of this good and trade it for other goods. A country has comparative advantage in whichever good it sacrifices the least.

Example  Ireland has a comparative advantage in cheese and butter due to climate and a large amount of land suitable for dairy cows. China has a comparative advantage in electronics because it has an abundance of labor.

Comparative advantage explains why a country might produce and export something its citizens don't seem very skilled at producing when compared directly to the citizens of another country.

For example, in the past few years India has become a major supplier of phone-answering services for the American market, even though their English-language skills are not up-to-par.

The explanation of the apparent paradox is that the citizens of the importing country must be even better at producing something else, making it worth it for them to pay to have work done by the exporting country. The citizens of each country are better off specializing in producing only the goods at which they have a relative cost advantage, even if one country has an absolute advantage at producing each item.