Free Trade and Protection

Sources of Comparative Advantage

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Christian Bien

Learning Objectives

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What is International Competitiveness?
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Comparative advantage is where a country can produce a good or service with the lowest opportunity cost. Countries that specialise and produce goods and services that they have a comparative advantage in can experience a mutual gain in trade. Think of comparative advantage as those who can sell at the lowest price while still producing economic benefits for the country.

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What are the Sources of Comparative Advantage?
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Comparative advantage is determined by a country's resources, that is the land, labour, capital and enterprise. 


Source #1: Land 

  • The natural resources available to a country.

  • Endowment of natural resources

  • Climate


Source #2: Labour

  • The skills and wage costs of the labour force.

  • Quality of labour force - skilled and qualified workforce to ensure labour productivity

  • Quantity of labour - size of the labour force - Wage costs of labour 


Source #3: Capital 

  • The availability and quality of the machinery and other capital goods in the country 

  • The quality of capital - is the production of goods and services using the latest technology?

  • Quantity of capital - capital to labour ratio 


Source #4: Enterprise 

  • The managerial processes, technological change and R&D available to a country

  • Managerial processes to ensure the efficiency of labour and capital

  • Utilising technological change

  • Leading research and development 


Source #5: Other Factors

  • Exchange rate (note this is always changing)

  • Level of protectionism

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Case Study: Australia's Comparative Advantage in Iron Ore
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The Australian economy is one of the most competitive in the production of iron ore, which is mainly driven by the country's naturally rich resource deposits of high-quality iron ore. In addition, the structure of the labour force is ideal for the production of iron ore. Iron ore is highly capital intensive, which is advantageous on Australia's small but highly skilled labour force. 


While Australia's mining wages are very high, they are compensated by high levels of capital deepening, increasing labour productivity and driving down unit costs of production. Australia's low level of protection and formation of trading partners such as those with China, Japan and Korea, make accessing iron ore export markets easier. 


As a result, it was estimated in 2021 that the cost of BHP to produce iron ore in Western Australia could be as low as US$14 - $15 per tonne. In July 2021, the price of Iron Ore reached around US$215 per tonne. Not a bad profit per tonne?

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Significance of Trade to the Australian Economy
Sources of Comparative Advantage
Calculating Comparative Advantage
The Principle of Comparative Advantage
Forms of Protectionism
Demonstrating Gains in Trade
Tariff Model
Subsidy Model
Positives of Trade Liberation
Negatives of Trade Liberation
Trade Agreements, Blocs and Organisations
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