Use the resource-based and institution-based views to answer why nations trade.

Use the resource-based and institution-based views to answer why nations trade.

 

 

 

Answer:

Two countries trade because of their difference in labour productivity. Some countries have an absolute advantage and comparative advantage in the production of goods.

Absolute Advantage:

Absolute advantage is the ability of a country to produce a good or service at a lower per unit cost as compared to any other country that produces same good or service.

Comparative Advantage

Comparative cost advantage theory was formulated by Ricardo. This model of international trade is also referred as 2X2X1 model. It means that there are 2 countries producing 2 goods by using only one factor of production i.e. labour.

According to this theory, a country has comparative advantage in producing that good if opportunity cost of producing that good is lower in that country as compared to other country. This approach in which international trade arises due to difference in productivity of labour is known as Ricardian Model of International Trade.

Let us assume that there are two countries, UK and India who produces rice and tea.

UK requires 4 and 5 units labour to produce 1 unit of tea and rice respectively. On the other hand, India requires 5 and 4 units of tea and rice respectively.

So, Opportunity cost in UK:

4 units of tea = 5 units of rice

implies, 1 unit of tea = 5/4 or 1.25 unit of rice or 1 unit of rice = 4/5 or 0.8 units of tea

Opportunity cost in India:

5 units of tea = 4 units of rice

implies, 1 unit of tea = 0.4 unit of rice or 1 unit of rice = 1.25 units of tea

Since, opportunity cost of producing tea is less in India, so India has comparative advantage in the production of tea. Opportunity cost of producing rice is less in UK so UK has comparative advantage in the production of tea. So, India will export tea to UK and UK will export rice to India.

Asked on February 15, 2018 in economics.
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