The Law of Comparative Advantage

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This note deals with the Law of Comparative Advantage, a concept connected with international trade. We also run through the limitations of the law.
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The Law of Comparative Advantage

The Law of Comparative Advantage states that a country should specialise in the production of those goods at which it is relatively most efficient, and obtain its other requirements through international trade.This indicates that any country, regardless of their current level of economic development, can find something at which they are relatively most efficient at producing.

Limitations of the Law of Comparative AdvantageA handy way to remember these is the acronym FROSTF = Free TradeR = Constant ReturnsO = Occupational MobilityS = Reasons for Avoiding Specialisation IgnoredT = Transport Costs

Assumes Free Trade ExistsThe Law of Comparative Advantage (LCA) assumes that governments do not interfere with the gains made from trade. In reality, governments interfere quite a lot with trade, through import duties etc.

Assumes Constant ReturnsThe LCA does not take into account the principles of the Law of Diminishing Marginal Returns

Assumes Workers are Occupationally MobileWorkers needs to learn skills for producing different things, and they cannot switch straight away from producing one thing to another if the country decides to only focus on producing one thing

Ignores Reasons for Avoiding SpecialisationThe LCA encourages specialisation of a narrow range of goods, but doesn't take into account the risks inherent in such a practice.For example, there is a high risk of shortage if supply is suddenly interrupted due to an unforeseen occurrence, and this will result in a substantial drop in earnings.

Ignores Transport CostsOften, transport costs can be so high as to render the gains from international trade minimal, if not negative.The LCA disregards these transport costs.

The Law of Comparative Advantage

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