In economics, there is a theory known as comparative cost theory. According to this theory, countries should specialize in the production of those goods and services where they have a comparative advantage over other nations. In other words, they should produce those goods and services which can be produced by them at a lower cost than their competitors. In order to have a better understanding about this concept one should look at some of the advantages and disadvantages of comparative cost theory -.
Advantages of Comparative Cost Theory
Economic Efficiency
The first and foremost of comparative cost theory is that it leads to greater economic efficiency. When countries specialize in the production of goods and services where they have a comparative advantage, they can produce more output with the same amount of inputs. This means that they can use their resources more efficiently and produce more output overall. In simple words just like a student if he or she is strong in mathematics than he or she will complete the mathematics topics swiftly as compared to other subjects where the student is weak in the same way countries also function where they can produce more output due to specialization.
Comparative Cost Theory leads to Economic Growth
Another advantage of Comparative Cost Theory is that it leads to greater economic growth for a country. When countries specialize in the production of goods and services where they have a comparative advantage, they can produce more output which than can be exported to other nations thus helping the country to earn valuable foreign exchange which can be used by the country to grow their economies more rapidly and hence leading to economic growth for the country.
Promotes International Trade
Finally, comparative cost theory also helps to promote international trade. When countries specialize in the production of goods and services where they have a comparative advantage, they can sell their products to other countries and import other products where they do not have a comparative advantage. This will lead to more international trade between the nations and thus promote international trade at the global level.
Disadvantages of Comparative Cost Theory
Ignores Opportunity Cost
One of the biggest disadvantages of comparative cost theory is that it does not account for opportunity cost. Opportunity cost is the cost of not pursuing a certain course of action. For example, if Country A can produce a good for $100 and Country B can produce the same good for $120, Country A has a lower comparative cost. However, if Country A can produce a different good for $90, then the opportunity cost for Country A is $10 which is the difference in cost between the two goods. This opportunity cost is not taken into account in comparative cost theory.
Economies of Scale
Another disadvantage of comparative cost theory is that it does not account for economies of scale. Economies of scale refer to the cost savings which happen when a company produces more goods as fixed costs tends to get distributed resulting in lower cost per unit and if a country despite having comparative cost disadvantage is able to use economics of scale effectively then there is no need for imports from the country having comparative cost advantage.
Comparative Cost Theory ignores Transportation Costs
Finally, comparative cost theory does not take into account transportation costs. Transportation costs are the costs associated with moving goods from one place to another. For example, if it costs $100 to produce a good in Country A and $120 to produce the same good in Country B, but it costs $50 to transport the goods from Country A to Country B, then the total cost of producing and transporting the goods is $150. Hence if one takes into account the transportation cost than country B is better off in producing the goods rather than importing goods from country A.
As one can see from the above that comparative cost theory has advantages as well as disadvantages and that is the reason why any country thinking of adopting this theory for practical purposes should carefully read the above points and then only should take any decision.