Wednesday, 25 March 2009

Comparative advantage exists when one country has lower opportunity cost of production a particular product than another. For example if country X produces 100 of pineapples and 200 of sweet potato and country Y produces 300 pineapple and 900 sweet potatoes. For country X the opportunity of producing extra pineapple will be 2 sweet potatoes, however for the country Y the opportunity cost of producing extra pineapple will be 3 sweet potatoes. So the country X has a comparative advantage in producing pineapples. However if the country Y shifts to producing more sweet potatoes, the opportunity cost will be 1/3, while for the country X it will 1/2, so the country Y in this situation will have a comparative advantage. 
Factors that create the concept of comparative advantage are ability of switching to another industry without losses in efficiency, returns to scale (if increase in inputs in one industry leads to an increase in total output), if no externalities arise from consumption/producing.

There are also factors which determine the cost of production:
- Quantity and quality of labour available (more educated and skilled labor will provide bigger advantage for the country)
- Investment and improvements in technology which also lead to an increase in advantage
- Import controls which limit international trade and create advantage for domestic producers
- Exchange rates: high exchange rates will make exports more expensive and less competitive and thereby country might loose its advantage

(tried to explain this topic, but not sure if im right:)