Absolute and Comparative Advantage

In international economics, absolute advantage is described as a person’s (a firm’s, a country’s, or a party’s) capacity to locally produce more units of product or service with the same amount of capital as another foreign competitor (Levchenko & Zhang, 2016). The estimate is based on a straightforward comparison of labor productivity. Furthermore, comparative advantage denotes the need for an individual, nation, or nation to specialize in the development and exportation of services and goods or items that it can produce at the lowest cost while importing services and products that it has a disadvantage producing. The table below shows the amount of labor required to provide a unit of output of lumber or beef in both Brazil and Argentina.

Table 1: Labor Requirements per Unit of Output

Brazil

Argentina

Lumber

5

7

Beef

4

5

Brazil has an absolute advantage in the production of lumber and beef because, from the data, one unit of lumber requires five units of labor as compared to seven in Argentina. Also, a unit of beef needs four units of labor as opposed to 5 units in Argentina. Now assume that labor cost $10 in Brazil and $7.5 in Argentina. However, these price of labor Argentina has a comparative advantage in the production of beef since a unit of beef will cost $37.5 which is comparatively lower than $40 needed in Brazil. From the information available above Argentina should specialize in the production of beef and import lumber. Besides, Brazil should import beef and specialize in the production of lumber. Specialization will enable the two countries to benefit from international trade.

Circular Flow

An Individual fall under households in the circular flow of income and would represent labor and consumption part of the stream. Households own the resources of production which firms buy in exchange for finished products, salaries, and wages (Murray, Skene & Haynes, 2017). The diagram helps in understanding economic agents in the market in three ways. One, it reduces the heterogeneous agents in the economy into homogeneous groups that simplify the concept of the flow of income. Next, it highlights the knowledge of interdependence by signifying the interrelationships between economic activities. Finally, outlining the eternal nature of commercial activities implying that the businesses can never halt at any instance.

References

Levchenko, A. A., & Zhang, J. (2016). The evolution of comparative advantage: Measurement and welfare implications. Journal of Monetary Economics, 78, 96-111.

Murray, A., Skene, K., & Haynes, K. (2017). The circular economy: An interdisciplinary exploration of the concept and application in a global context. Journal of Business Ethics, 140(3), 369-380.