Question

Define, explain, and give real world examples of the two free trade concepts of absolute advantage and comparative advantage as developed by Adam Smith and David Ricardo. Define, explain, and give real world examples the 3 free trade theories that support Smith and Ricardo absolute and comparative advantage theories. Define, explain, and give real world examples protectionism and protectionists tools. Explain the difference between free trade and fair trade.

Answer 1

Absolute advantage

A country has an absolute advantage in the production of a good when it can produce it more efficiently than other countries. Absolute advantage refers to the ability of a country to produce a good more efficiently than other countries. In other words, a country that has an absolute advantage can produce a good with lower marginal cost (fewer materials, cheaper materials, in less time, with fewer workers, with cheaper workers, etc.). Absolute advantage differs from comparative advantage, which refers to the ability of a country to produce specific goods at a lower opportunity cost.

Comparative advantage

A country has a comparative advantage over another when it can produce a good or service at a lower opportunity cost. Even if one country is more efficient in the production of all goods (has an absolute advantage in all goods) than another, both countries will still gain by trading with each other. More specifically, countries should import goods if the opportunity cost of importing is lower than the cost of producing them locally.

Examples

• One of America's comparative advantages is its vast land mass bordered by two oceans. It also has lots of fresh water, arable land, and available oil. U.S. businesses benefit from cheap natural resources and protection from land invasion.
• Oil-producing nations have a comparative advantage in chemicals. Their locally-produced oil provides a cheap source of material for the chemicals when compared to countries without it. A lot of the raw ingredients are produced in the oil distillery process. As a result, Saudi Arabia, Kuwait, and Mexico are competitive with U.S. chemical production firms.
• Another example is India's call centers. U.S. companies buy this service because it is cheaper than locating the call center in America. Indian call centers aren't better than U.S. call centers. Their workers don't always speak English very clearly. But they provide the service cheaply enough to make the tradeoff worth it.
• Nations that are blessed with an abundance of farmland, fresh water, and oil reserves have an absolute advantage in agriculture, gasoline, and petrochemicals. Just because a country has an absolute advantage in an industry doesn't mean that it will be its comparative advantage.

Examples of Protectionism and Protectionist tools

Anti-Dumping tariffs

‘Dumping’ occurs when firms sell goods below a ‘fair market price’ e.g. below cost, because of excess supply. This can flood a domestic market with cheap imports and make it difficult for domestic firms to stay in business. In this case, countries may justify tariffs on the grounds they are preventing this damaging effect of dumping. Tariffs are justified by the WTO, if you can prove dumping is occurring.

Illegal Subsidies

Another form of protectionism occurs when a country gives a subsidy or support to a domestic export industry. This gives the exporters an unfair advantage in the world market.

Difference between free trade and fair trade

Free Trade

Free trade has played a major role in countries’ trade policies and the international trading system for the past few decades. Free trade is guided by government policies and agreements, such as the divisive Trans-Pacific Partnership (TPP), a transnational trade agreement between 12 nations in the Asia-Pacific and Americas.

Fair Trade

The fair trade movement is an approach to development in which businesses partner with artisans and farmers to create more equitable trading relationships. Fair trade organizations are guided by overarching principles that seek to empower marginalized producers and improve the quality of their lives. The fair trade movement is driving change through ensuring living wages and safe working conditions in disadvantaged areas of the world as well as empowering the communities with long-term commitments and relationships