Comparative Advantage and the Principle Theories of Trade

Comparative Advantage and the Principle Theories of Trade

Sample Comparative Advantage Essay Paper:

Comparative advantage describes a situation in which an individual or company can sell goods and services that are offered by rival companies/individuals at a deflated price and consequently realize better sales margins. Comparative advantage results from different factors such as the availability of raw materials, better energy costs and better incentives from the government that a company can enjoy over a rival company in another country. Therefore different companies can gain strategic advantage by knowing how they can reduce the opportunity cost while maximizing sales and services offered (Porter, 2011).
Comparative Advantage and the Principle Theories of Trade

Comparative advantage as a result occurs mostly between or among different countries as they import and export goods. Trade occurs predominantly due to different price valuation of goods or services .Prices vary due to either a specific good being in abundance or whether it is scarce. Different countries have varying levels of technological developments in their industries and varying reserves of natural resources and that can be exploited to enable a country have comparative advantage. Ricardo’s theory explains in detail the discrepancy in technological developments between countries. It basically states that country will mainly only export goods which it considers it can get the maximum comparative cost advantage, with all other factors kept constant. Ricardo’s theory has a number of assumptions:

1. Two countries are involved and only two commodities are dealt with.

2. No cost of transportation involved

3. Labor is assumed to have identical productivity.Technology does not change in a given country.

4. Trade is not hindered between the countries.

5. Labor can move freely within a country but cannot do the same between countries.

6. Barter system of trade is adopted.

7. Value of the goods or service rendered is measured by the number of hours required to manufacture it.

8. Perfect competition occurs both in commodity and factor market.

The variance in resources available to a country is explained by Heckscher-Ohlin model. This model basically explains how a country will more likely export goods or product based on their resource endowment and look to import products or goods that use the country’s scarcest resources.

The two models have a few differences. The Ricardian model uses one input but the Heckscher-Ohlin(H-O) model uses two inputs. Free trade does not hurt the factor in Ricardian model. In the H-O model free trade benefits the country with large reserves of resources while hurting those with scarce.

Some countries are able to massively benefit from having large populations as this means they have cheap labor readily available for example China. Good climate and fertile land also enables a country produce massive amount of agricultural products that gives them an edge during trading. The strength of a nation’s currency against their competitor can drive up the profit margins exponentially in the markets. Some countries are known to have put in place a lot of money to encourage innovation and improvement of the ways in which it can handle its dealings in the export/import markets. Good governance and political stability in a country encourages investors from other countries to invest, it creates stability and enable businesses to flourish. Some countries are also known to provide commodities of exceptional quality such that they register a high demand. This has the advantage of consolidating a country’s position as a market leader and the clout to expand their markets. A good example is the German automotive industry. Some countries provide export subsidies for domestic companies while imposing high tariffs on imports so as to artificially create a comparative advantage to its own local companies. Most nations around the world are known to adopt this method (Grubel, 2014).

International factor movements refer to the transfer of the workforce, capital, and the inputs to the manufacturing process in companies. It occurs in three ways:immigration,foreign direct investment and borrowing or lending of money for businesses. This has led to nations having measures to reduce these movements which can specifically jeopardize their own comparative advantage. Nations are known to amend immigration rules to curb infiltration of foreigners, reduce financial assistance and foreign investments (Dunning,2013). Such kind of measures are understandable especially when a country wants to guard their advantage over the rival enables countries be able to focus solely on what they are specialized in producing in order to preserve their comparative advantage. However this method also has disadvantages. A country is unable to benefit from fresh and innovative ideas from the other countries that may in fact improve the quality of products while lowering the opportunity cost substantially. It also creates animosity with the other countries such that they will reciprocate in exactly the same manner and as a result this kind of atmosphere stifles free market.

Policies that a government adopts have far reaching consequences to its local industries and the countries it chooses to deal with. High tariffs are usually placed to countries that a rival enjoys little to no comparative advantage.This may be because they all have almost similar commodities.If it were to allow free movement completely it would lead to flooding of the markets and this would lead to massive losses that most governments would not countenance. High tariffs also enable a government get taxes that can be later used to improve the quality of services offered to the local companies. This can for example be done by reducing the energy costs. It can also put in place tax waivers to motivate the local companies toproduce maximum output. Nontariff barriers are made to maximize on the free trade that would arise as a result. This is mostly done by national governments who have a shortage of commodities due to maybe a lack of endowment with resources. It has the ability of fostering co-operation between countries by building healthy trade relations .The other country may reciprocate by also dropping tariffs on imports it lacks (Trebilcock, 2012). Governments may thus make trade policies that are geared to make a country sustainable on its own first. This is done by doing a study to ascertain exactly whether a country has the necessary resources and technological know how to stand out as an economic powerhouse. This must be done with a vision of positioning a country to be able to be very efficient in at least a commodity that can be used as a bargaining tool when trying to establish comparative advantage.

Governments can also create policies that encourage job creation in the manufacturing sector. This in turn enables companies benefit from young innovative minds and the necessary workforce to be able to yield maximum productivity. Policies are sometimes also put in place to improve relations between the trade unions and the government in order to provide a line of communication so that the stakeholders can always talk on the policies that they think can work on the existing market trends and conditions.

A number of countries employ varying types of national policies that they feel are best for their countries. Countries like North Korea practice autarchy where hey believe in only products from their own countries and completely block out trade with others. However, this method is outdated and is practiced scarcely.Other countries practice mercantilism where the nation believes another nation’s loss is their gain and as a result prefer mass exportation while restricting importation (Narlikar, 2013). Fair trade is a new type of policy adopted by European nations where the buyer goes directly to the buyer while ignoring the middlemen. This ensures that the producer sells the commodities at a lower price while at the same time earning healthier profit margins. Comparative advantage is gained by both the buyer and the seller.. Finally, another policy used is the free trade that ensures there is no restriction on trade. This ensures market flexibility as a nation can easily gain comparative advantage over a number of nations that lack the goods a country has to offer.


Dunning, J. H. (2013).International Production and the Multinational Enterprise (RLE International Business) (Vol. 12).Routledge.

Grubel, H. G. (2014). A theory of multinational banking.PSL Quarterly Review, 30(123).

Narlikar, A. (2013). International Trade and Developing Countries: Bargaining Coalitions in GATT and WTO. Routledge.

Porter, M. E. (2011). Competitive advantage of nations: creating and sustaining superior performance. Simon and Schuster.

Trebilcock, M. J., Howse, R., & Eliason, A. (2012).The regulation of international trade.Routledge.


Leave a Reply

Your email address will not be published. Required fields are marked *