Criticisms of Comparative Advantage

• Law of comparative advantage


  A country should specialize in the production of a good or service that can produce the lowest opportunity cost, then it should trade, and for trade to be mutually beneficial there needs to be a suitable exchange rate
• The end result of countries specializing where they have comparative advantage is that prices are lower and they can maintain that advantage for a long period of time
• In the real world, there are lots of limitations to the theory of comparative advantage which explains why lots of different countries will produce the same kinds of goods and services and why a country that might have a comparative advantage may actually struggle to sell its business services abroad despite what the theory says
• Limitations of the comparative advantage model

  • Assumes perfect knowledge - consumers may not know where the lowest prices are
  • Assumes no transport costs - these can distort the advantage
  • Assumes constant returns to scale - economies of scale can distort the advantage
  • Assumes no inflation - relative inflation rates can erode the advantage
  • Assumes no import controls - tariffs and quotas can erode the advantage
  • Ignores non-price competitiveness - factors like brand, quality, innovation can dominate
  • Ignores exchange rates - strong exchange rates can erode the advantage
  • Ignores R&D investments - these can lead to product differentiation and monopolies
• The limitations of the comparative advantage model help explain why in the real world you have lots of different countries producing similar goods and services