Economics And Trade: The Study Of Limited Resources And Specialization

Scarcity and Opportunity Cost

Economics is regarded as the study of limited resources. The primary reason for considering the resources scarce since they human wants are unlimited and resources are scarce. There prevails a constant trade-off among the varied wants in an economy. To manufacture more it requires making sacrifice of other goods (Bernanke, Antonovics and Frank 2015). The purpose of economics is to distribute the resources that are scarce sufficiently among the people to meet their wants. The concept of trade arises from the necessity of equal use of resources. When a nation specializes itself particular commodity then the resources are divided in an effective manner among the commodities. Several models of trade have been developed to ascertain the line of specialization for nations.

Adam Smith created the pioneering model of trade that is commonly known as “Theory of Absolute Advantage” (Ginzberg 2017). The theory though failed to offer sufficient explanation of all the possible circumstances. Later David Ricardo created the Theory of Comparative Advantage to explain the route of specialty (Huberman and Sharma 2016). Additionally, several economist have introduced different models of trade to determine the evaluation of trade amid the two more countries. Prior to discussion of comparative advantage and other noteworthy models of trade that are explaining distribution, production and consumption of limited resources it is vital to determine the difficulties of scarce resources in a nation.

Prof. Lionel Robin initially introduced the problems of scarcity in the definition of economics made in 1930. The description of scarcity refers to the supply resources in respect to demand (Cowen and Tabarrok 2015).  The main problem is the unlimited human wants and limited resources to meet the demand. The main factors of productions comprise of land, labour, capital and entrepreneur that are used to equally increase the amount of production. The problems of scarcity is chief economic problems and the initially the problems of selection is the largely faced by an economy. The problems of selection includes the notion of opportunity cost. The opportunity on the other hand refers to sacrifice of income to obtain the next best alternative. In an economy labour faces the difficulties amid the labour intensive choices. Increased work efforts results in increased income but requires making sacrifice of leisureliness. The opportunity of cost and problems of selection is relevant in nations during resources allocation and varied production choices. For a better understanding, the theory of production possibility curve is studied to reflect the production boundary of a country.    

Absolute Advantages and Evaluation of Comparative Advantage

 

Figure 1: Production Possibility Curve

(Source: Sunley 2017)

As evident from the above stated figure production increase in production of one product requires reducing the production of other goods. The production possibility curve assumes the concept that a nation can produce two goods from all their resources (Mateer and Coppock 2017). The problems of resources allocation and problems of section paves way for three main question that is faced by an economy. These include, what to produce, how to produce and for whom to p[reduce. Trade relations with the help of specialization and exchanges provides answer to these questions.

Absolute advantages and evaluation of comparative advantage: Absolute cost differences originates when a nation can produce a commodity at the absolutely lower amount of cost in comparison to other country and the other country can produce certain other commodity than the other nation at a lower price (LeRoy and Werner 2014). The cost differences can be explained with the help of illustrated example. The below listed explains productions of the two commodities by making use of 10 days of labour in India and Bangladesh;

Country	Cotton (Units)	Jute (Units)	Domestic Exchange Ratios
India	100	50	1C = ½ J 1J = 2C
Bangladesh	50	100	1C = 2J 1J = ½ C

As evident from the table above by using 10 days of labour India can produce 100 units of cotton and 50 units of Jute. Whereas Bangladesh from the same amount of labour can produce 50 units of cotton and 100 units of Jute. The illustrations evidently provides that India has absolute cost advantage in producing cotton and Bangladesh holds advantage in production of Jute. Alternatively, India has absolute disadvantage in the production of jute while Bangladesh has in the production of cotton (Ehrenberg and Smith 2016). Therefore, both the nations would gain if they specialize in their respective goods and exchange the commodities of each other.

The theory evidently puts forward that when a country holds the absolute cost advantage in production of both the goods then specialization must be defined in terms of opportunity cost and production (Ginzberg 2017). This is due to resource constraints manufacturing of each goods requires opportunity cost. Specialization must be performed on goods where a nation holds a lower opportunity costs.

David Ricardo emphasised that comparative cost advantages form the basis of international trade. When a nation has the absolute superiority over the other country in both the commodities it would be beneficial for that nation to specialize in that product in which it enjoys comparative advantage (Nas 2016). The illustration of comparative cost advantage is illustrated with the help of rice and wheat between India and Bangladesh.

Country	Rice	Wheat
India	20	8
Bangladesh	8	4

Specialization and Gains from Trade

As evident from the above stated table the relative productive ratio for rice stands 2.5 whereas the relative productive ratio for wheat stands 2. Therefore, it would be advantages for India to specialize in the production of rice as India enjoys relatively greater efficiency than Bangladesh. Similarly, it can be proved that Bangladesh has relatively lower comparative advantage in the production of wheat. The relative productive ratio for wheat is higher as compared to the productive ratio for rice (0.5>0.4) in the situation of Bangladesh.

Specialization and gains from Trade: With the prevelant of different opportunity in cost of production both the nation can benefit from the specialization in goods in which it has comparative advantage (Flake et al. 2015). Bangladesh requires 10 units of labour to produce one unit of rice but after engaging in trade with India it can exchange one of unit of rice for one unit of wheat.

The concept of comparative cost advantage is more beneficial in than the absolute cost advantage however the theory suffers from limitations which prevents in the explanation of dynamics of trade. An important element of exchange is the transportation cost based on the physical distance between the states. The cost involved in transportation constantly offset the benefits obtained from the comparative advantage. The comparative cost advantage ignores the element of social-political cost (Do, Levchenko and Raddatz 2016). A nation producing only one unit of goods over a period of long time resulting in monotonous fall in productivity leading to diseconomies of scale in long run. The theory of Ricardo takes into the account only sole factors of productions i.e. labour but in actual situation other factors of production are also used which is ignored in the theory. 

Unlike Ricardo’s model Heckscher Ohlin model does not need different techniques of production instead of assuming identical techniques of production. The model of H-O helps in eliminating the technical variances however comprises of additional factors of production. The model helps in explaining the differences of labour productivity which is presumed in the Ricardian Model (Chakrabarti and Ramaswamy 2015). The model recognizes nations as labour abundant and capital abundant depending upon the factor endowment.

As per this theory of labour abundant a nation must specialize in the capital intensive goods. One such example includes USA which is a capital intensive nation and according to Heckscher Ohlin it must specialize itself in capital intensive goods (Levchenko and Zhang 2016). Actually, USA is known for exporting large number of labour goods and capital goods which is directly in contrast to the theory of trade proposed by Heckscher and Ohlin. An explanation put forward by Leontief explains that labourers in US are more efficient than foreign labours.

Heckscher Ohlin Model

Another important aspect in international trade is the intra-trade industry that takes place when goods and services are exchange between countries that operate in similar industry. This reflects that process of intra industry trade countries engages in exchange of beverage, vehicles, food products and computers (Costinot et al. 2015). For instance, Europe in 2002 exports automobiles amounting to 2.6 million. In the present year import of automobiles for Europe stood 2.2 million.

Reymond Vernon provides explanation of inconsistency of Heckscher Mode through the theory of product life cycle. The theory explains that during the early stage of production all the elements and associated labour is initially associated to the area where the factors are invested. Following the adaption and acceptance of product in the international market, it slowly drifts away from the origin of invention. The goods regularly become an item of import from the country of origin (Huberman and Sharma 2016). An application of the theory is noticed in patterns of trade in US which is related to invention, growth and production of personal computers. Initially, the production and consumption takes place in US with no import or export. Once the product attains the maturity stage the mass production techniques adopted with the increase in overseas demand. Later US exports the product to other countries. During the transitional stage of production shifts to the developing countries and slowly the countries attains the stage where products are exported to developed nations.

            

Figure 2: Figure illustrating Product Life Cycle

(Source: Huberman and Sharma 2016)

The Porter’s Diamond Model provides an explanation of a nations competitive position in the international market. The primary reason for calling the model as Diamond because all the relevant elements of competitive international business appears in the shape of diamond.  

Figure 3: Figure reflecting Porter’s Diamond Model

(Source: Ginzberg 2017)

A country uses the Porter’s Diamond Model to transform a countries national advantage to the global advantage. An explanation to the model is that the home based advantage provides a nation help in creating an advantage in the internal scale (Ginzberg 2017). The determinants of these benefits represents factor conditions, success associated to supporting industries, demand factors in home nation and organization strategy with the existence of rivalry.

Conclusively the essay summarizes the mechanism of distribution of scarce resources internationally by using the principle of different models of trade. Each models possess their own advantage and disadvantage. The absolute cost advantage was the first ground-breaking theory of international trade. The model was failure in explaining the trade among the countries where one country has absolute cost advantage over the other products. The matter was latter addressed by David Ricardo theory of Comparative cost advantage. There are other noteworthy models of trade that makes significant amount of contribution in explaining the patterns of trade including the Hechscher-Ohlin model, intra-industry model of trade, product life cycle theory and Porter’s Diamond model. 

Reference List:

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Chakrabarti, A. and Ramaswamy, V., 2015. Rethinking Comparative Advantage in a Co-Creation Economy.

Costinot, A., Donaldson, D., Vogel, J. and Werning, I., 2015. Comparative advantage and optimal trade policy. The Quarterly Journal of Economics, 130(2), pp.659-702.

Cowen, T. and Tabarrok, A., 2015. Modern principles of economics. Palgrave Macmillan.

Do, Q.T., Levchenko, A.A. and Raddatz, C., 2016. Comparative advantage, international trade, and fertility. Journal of Development Economics, 119, pp.48-66.

Ehrenberg, R.G. and Smith, R.S., 2016. Modern labor economics: Theory and public policy. Routledge.

Flake, J.K., Barron, K.E., Hulleman, C., McCoach, B.D. and Welsh, M.E., 2015. Measuring cost: The forgotten component of expectancy-value theory. Contemporary Educational Psychology, 41, pp.232-244.

Ginzberg, E., 2017. Adam Smith and the founding of market economics. Routledge.

Huberman, B.A. and Sharma, P., 2016. Comparative advantage driven resource allocation for virtual network functions. arXiv preprint arXiv:1603.03834.

LeRoy, S.F. and Werner, J., 2014. Principles of financial economics. Cambridge University Press.

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

Mateer, G.D. and Coppock, L., 2017. Principles of economics. WW Norton.

Nas, T.F., 2016. Cost-benefit analysis: Theory and application. Lexington Books.

Sunley, P., 2017. Principles of economics. Regional Studies, 51(8), pp.1281-1282.