Comparative Advantages

Comparative advantages

The ability of the country to produce goods at the lower opportunity cost than another country.

COUNTRY	Motorcycle	Car
MALAYSIA	100	300
JAPAN	250	350
TOTAL	350	650

Before trade

·         Before occurrence of trade, Malaysia has issued as much as 100 units of Motorcycle and 300 units of Car. While, country Japan have issued as much as 250 units of Motorcycle and 350 units of Car.  

·         Before occurrence of trade, the amount of total world output is 350 units of Motorcycle and 650 units of Car. 

Opportunity cost

·         Desired goods that one has to forgo to obtain other goods.

·          Every country would produce goods at the lowest opportunity cost compared to other country. 

 

COUNTRY	Opportunity cost/motorcycle	Opportunity cost/ car
MALAYSIA	300/100 = 3	100/300 = 0.3
JAPAN	350/250 = 1.4	250/350 = 0.7

Specialization

COUNTRY	Motorcycle	Car
MALAYSIA	0	600
JAPAN	500	0
TOTAL WORLD OUTPUT	500	600

·         Based on opportunity cost table above, Malaysia having lower opportunity cost in production of Car compared to Japan while Japan having lower opportunity cost in production of Motorcycle compared to the Malaysia. So, Malaysia having comparative advantage in production of Car, while Japan having comparative advantage in production of Motorcycle. 

·         So, after specialize Malaysia will produce car and Japan will be produce motorcycle.

·         Malaysia will export car to Japan and import motorcycle from Japan.

·         Japan will export motorcycle to Malaysia and import car from Malaysia.

·         The amount of total world output in producing car is 600 units and motorcycle is 500 units. So, production for car was decrease 50 units and production for motorcycle was increase 150 units.

                                

Upper and lower limit in export and import.

                                 i.            Upper Limit       =             1 Motorcycle : 3 Car      @            1 Car : 0.7 Motorcycle

                               ii.            Lower Limit      =             1 Motorcycle : 1.4 Car   @            1 Car : 0.3 Motorcycle

Term of trade (TOT)

·         Terms of trade show ratio between export price index with import prices index.

·          Term of trade used to determining amount exchange (export and import) between countries trade.

·         Example; Malaysia and China can export or import based on TOT 1 Motorcycle: 3 Car or 1 Motorcycle: 1.4 Car

.

If, uses the TOT 1 car : 2 motorcycle

Calculate the total import and export each of country if Malaysia want to export 200 Car to China.