Assumption of the Comparative advantage
- That there are only two countries that exist in the world.
- That the said countries produce only two commodities: X and Y or c coffee and cotton.
- There is factor mobility between nations.
- There is no measure of value (money) used but transaction between countries is through commodity exchange.
- There are no transport costs involved.
- Only one factor of production (labour) is used i.e. it considers manpower
- The labour costs determine the price of the two commodities i.e. the number of units of labour required to produce each.
- There is perfect competition in the goods and factor markets.
- There is no Absolute Advantage.
- There is perfect mobility within each country and no perfect factor mobility between countries.
- The state of technology is constant i.e it does not change.
- Factors of production are fully employed i.e it assumes a situation of full employment.
- That the two countries have similar tastes and preferences.
- There is free trade between countries.
- Absolute Advantage
- Absolute advantage occurs when given two commodities and quantity of resources, one country can produce both commodities more cheaply than the other. For example
|
Country |
Commodity X |
Commodity Y |
|
A |
120 |
100 |
|
B |
80 |
90 |
Therefore, country A
has an absolute advantage in the production of commodities X and Y. However,
country B should specialize in commodity X where it has a comparative advantage
because of producing commodity X (80/120) which is 1€ the cost of producing commodity
Y (90 / 100). And country A should specialization production of
commodity Y where it has a less comparative advantage; it costs (100/90 men) as
compared to 120/80 men).