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The theory of absolute advantage and the theory of comparative advantage are based on specialization. Specialization and thereafter trade will lead to better off for both the countries. However, some of the assumptions of these theories do not hold true in reality. Mobility of Resources: We had assumed in the two theories that resources could easily shift from one production to the other in the two countries domestically without any cost. But in reality it is not so. Land for tea may not be suitable for fruit juice in India. Labor, good at information technology, cannot be shifted for production of juice. Labor may have problem to shift to not only a new activity, but also to a new area (say from North-eastern India to South India). The assumption that resources cannot move from one country to the other also does not hold true. But domestic movement will be easier than the international movement. The movement of capital and labor may be a good alternative to trade. Movement of resources from one activity to the other creates conflicts and pain. It is best understood by those who have to bear the brunt. This is the reason the US information technology workers are opposing the shift of jobs to India (in the form of BPO). Employment: The two theories assume that available resources are fully employed. But when countries he unused or idle resources they will restrict the imports. Many of the developing countries' opposition to free trade is because of this reason that they cannot allow foreign technology and capital as they will displace many employed people. Economic Efficiency: The two theories assume that every country would go in for specialization so as to be economically efficient. Any country going in for over-specialization will become vulnerable to price fluctuations and technological changes. In the name of development and economic progress many countries do not allow the efficiency to ride over their cultural values or self-reliance to a large extent. Diminishing Returns: The two theories in general and the theory of comparative advantage in particular have assumed that there will be constant returns to specialization. It means the number of units of resources required to produce a good (tea or juice) will remain constant irrespective of level of production on the Tea PPF. The fact is that after a particular level of production, number of resources required per extra tonne may have to be increased, say from 30 units of resources to 40 units if the production of tea in India is to be increased from 10 tonnes. In such a case the PPF will be convex rather than straight line. This is true for the two reasons. One, all the resources are not of the same quality or having same productivity. Hence, to increase marginal production after a level less productive resources available shall be required in greater number. Two, production of different goods requires different combination of resources, like capital, labor, climate, land, etc. Cost of Transportation: In the two theories, cost of transportation between the countries was assumed away. In reality it is not so. If the cost of transportation is greater than the money saved through specialization, the trade will not take place. For example, it is cheaper for India to import chick peas from Pakistan than Australia due to cost of transportation involved. Division of Gains: It is true that trade brings in gains to every country, but it is not indicated as to how the two nations will share the increased output. Governments are always concerned with relative (in comparison to trading partners) as well as absolute economic growth. If the perception is that the other nation is getting a very high proportion of benefit, the first nation may sacrifice absolute advantage to stop relative loss. Free Trade and Economic Growth: The comparative advantage theory has not taken note of the fact that free trade between the nations can lead to increase in stock of resources due to international movement of factors of production. Secondly, free trade may also help a nation to increase efficiency of its resources, the way they are used (due to economies of scale, better technology from outside, local producers getting ready to face foreign competition). Many studies have confirmed the dynamic relationship between trade and economic growth. Higher the trade, higher the growth rate, higher the growth rate, higher the income levels - leading to better standards of living.
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Theory of Absolute Advantage and Comparative Advantage
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Theory Of Absolute Advantage And Comparative Advantage

Words: 737    Pages: 3    Paragraphs: 11    Sentences: 40    Read Time: 02:40
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              The theory of absolute advantage and the theory of comparative advantage are based on specialization. Specialization and thereafter trade will lead to better off for both the countries.
             
              However, some of the assumptions of these theories do not hold true in reality.
             
              Mobility of Resources:
             
              We had assumed in the two theories that resources could easily shift from one production to the other in the two countries domestically without any cost. But in reality it is not so. Land for tea may not be suitable for fruit juice in India. Labor, good at information technology, cannot be shifted for production of juice. Labor may have problem to shift to not only a new activity, but also to a new area (say from North-eastern India to South India).
             
              The assumption that resources cannot move from one country to the other also does not hold true. But domestic movement will be easier than the international movement. The movement of capital and labor may be a good alternative to trade.
             
              Movement of resources from one activity to the other creates conflicts and pain. It is best understood by those who have to bear the brunt. This is the reason the US information technology workers are opposing the shift of jobs to India (in the form of BPO).
             
              Employment:
             
              The two theories assume that available resources are fully employed. But when countries he unused or idle resources they will restrict the imports. Many of the developing countries' opposition to free trade is because of this reason that they cannot allow foreign technology and capital as they will displace many employed people.
             
              Economic Efficiency:
             
              The two theories assume that every country would go in for specialization so as to be economically efficient. Any country going in for over-specialization will become vulnerable to price fluctuations and technological changes. In the name of development and economic progress many countries do not allow the efficiency to ride over their cultural values or self-reliance to a large extent.
             
              Diminishing Returns:
             
              The two theories in general and the theory of comparative advantage in particular have assumed that there will be constant returns to specialization. It means the number of units of resources required to produce a good (tea or juice) will remain constant irrespective of level of production on the Tea PPF. The fact is that after a particular level of production, number of resources required per extra tonne may have to be increased, say from 30 units of resources to 40 units if the production of tea in India is to be increased from 10 tonnes. In such a case the PPF will be convex rather than straight line.
             
              This is true for the two reasons. One, all the resources are not of the same quality or having same productivity. Hence, to increase marginal production after a level less productive resources available shall be required in greater number. Two, production of different goods requires different combination of resources, like capital, labor, climate, land, etc.
             
              Cost of Transportation:
             
              In the two theories, cost of transportation between the countries was assumed away. In reality it is not so. If the cost of transportation is greater than the money saved through specialization, the trade will not take place. For example, it is cheaper for India to import chick peas from Pakistan than Australia due to cost of transportation involved.
             
              Division of Gains:
             
              It is true that trade brings in gains to every country, but it is not indicated as to how the two nations will share the increased output. Governments are always concerned with relative (in comparison to trading partners) as well as absolute economic growth. If the perception is that the other nation is getting a very high proportion of benefit, the first nation may sacrifice absolute advantage to stop relative loss.
             
              Free Trade and Economic Growth:
             
              The comparative advantage theory has not taken note of the fact that free trade between the nations can lead to increase in stock of resources due to international movement of factors of production. Secondly, free trade may also help a nation to increase efficiency of its resources, the way they are used (due to economies of scale, better technology from outside, local producers getting ready to face foreign competition). Many studies have confirmed the dynamic relationship between trade and economic growth. Higher the trade, higher the growth rate, higher the growth rate, higher the income levels - leading to better standards of living.
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