comparative advantage the advantage possessed by a country engaged in INTERNATIONAL TRADE if it can produce a given good at a lower resource input cost than other countries. Also called comparative cost principle. This proposition is illustrated in Fig. 24 with respect to two countries (A and B) and two GOODS (X and Y).
The same given resource input in both countries enables them to produce either the quantity of Good X or the quantity of Good Y indicated in Fig. 24. It can be seen that Country B is absolutely more efficient than Country A since it can produce more of both goods. However, it is comparative advantage not ABSOLUTE ADVANTAGE that determines whether trade is beneficial or not. Comparative advantage arises because the marginal OPPORTUNITY COSTS of one good in terms of the other differ as between countries (see HECKSCHER-OHLIN FACTOR PROPORTIONS THEORY).
It can be seen that Country B has a comparative advantage in the production of Good X for it is able to produce it at a lower factor cost than Country A; the resource or opportunity cost of producing an additional unit of X is only ⅔ Y in Country B, whereas in Country A it is 1Y.
Country A has a comparative advantage in the production of Good Y for it is able to produce it at lower factor cost than Country B; the resource or opportunity cost of producing an additional unit of Y is only 1X, whereas in Country B it is 1½X.
Both countries, therefore, stand to increase their economic welfare if they specialize (see SPECIALIZATION) in the production of the good in which they have a comparative advantage (see GAINS FROM TRADE for an illustration of this important proposition). The extent to which each will benefit from trade will depend upon the real terms of trade at which they agree to exchange X andY.
A basic assumption of this presentation is that factor endowments, and hence comparative advantages, are ‘fixed’. Dynamically, however, comparative advantage may well change. It may do so in response to a number of influences, including:
(a) the initiation by a country’s government of structural programmes leading to resource redeployment. For example, a country that seemingly has a comparative advantage in the supply of primary products such as cotton and wheat may nevertheless abandon or de-emphasize it in favour of a drive towards industrialization and the establishment of comparative advantage in higher value-added manufactured goods;
(b) international capital movements and technology transfer, and relocation of production by MULTINATIONAL COMPANIES. For example, Malaysia developed a comparative advantage in the production of natural rubber only after UK entrepreneurs established and invested in rubber-tree plantations there. See COMPETITIVE ADVANTAGE (OF COUNTRIES).
comparative cost principle see COMPARATIVE ADVANTAGE.
comparative static equilibrium analysis a method of economic analysis that compares the differences between two or more equilibrium states that result from changes in EXOGENOUS VARIABLES. Consider, for example, the effect of a change in export demand on the EQUILIBRIUM LEVEL OF NATIONAL INCOME as shown in Fig. 25. Assume that foreigners demand more of the country’s products. Exports rise and the aggregate demand schedule shifts upwards to a new level (AD2), resulting in the establishment of a new equilibrium level of national income Y2 (at point H). The effect of the increase in exports can then be measured by comparing the original level of national income with that of the new level of national income. See DYNAMIC ANALYSIS, EQUILIBRIUM MARKET PRICE (CHANGES IN).
compensation principle see WELFARE ECONOMICS.
competition 1 a form of MARKET STRUCTURE in which the number of firms supplying the market is used to indicate the type of market it is, e.g. PERFECT COMPETITION (many small competitors), OLIGOPOLY (a few large competitors). 2 a process whereby firms strive against each other to secure customers for their products, i.e. the active rivalry of firms for customers, using price variations, PRODUCT DIFFERENTIATION strategies, etc. From a wider public interest angle, the nature and strength of competition has an important effect on MARKET PERFORMANCE and hence is of particular relevance to the application of COMPETITION POLICY. See COMPETITION METHODS, MONOPOLISTIC COMPETITION, MONOPOLY.
Fig. 25 Comparative static equilibrium analysis. The initial level of national income is Y1 (at point A) where the AGGREGATE DEMAND SCHEDULE (AD1) intersects the AGGREGATE SUPPLY SCHEDULE (AS).
Competition Act 1980 a UK Act that extended UK COMPETITION LAW by giving the OFFICE OF FAIR TRADING (OFT) wider powers to deal with restraints on competition such as EXCLUSIVE DEALING, TIE-IN SALES, etc. Previously, these practices could be dealt with only in the context of a full-scale and lengthy monopoly probe, whereas the Act now allows the OFT to deal with them on a separate one-off basis. See COMPETITION POLICY (UK).
Competition Act 1998 a UK Act that consolidated existing competition laws but also contained new prohibitions, powers of investigation and penalties for infringements of the Act. The Act is designed to bring UK competition law into line with European Union competition law as currently enshrined in Articles 85 and 86 of the Treaty of Rome.
The Act covers two key areas of competition policy: anti-competitive agreements and market dominance.
(a) The Act prohibits outright agreements between firms (i.e. COLLUSION) and CONCERTED PRACTICES that prevent, restrict or distort competition within the UK (the Chapter 1 prohibition). This prohibition applies to both formal and informal agreements, whether oral or in writing, and covers agreements that contain provisions to jointly fix prices and terms and conditions of sale; to limit or control production, markets, technical development or investment; and to share markets or supply sources.
(b) The Act prohibits the ‘abuse’ of a ‘dominant position’ within the UK (the Chapter 2 prohibition). The Act specifies dominance as a situation where a supplier ‘can act independently of its competitors and customers’. As a general rule, a dominant position is defined as one where a supplier possesses a market share of 40% or above. Examples of ‘abuse’ of a dominant position specified in the Act include charging ‘excessive’ prices, imposing restrictive terms and conditions of sale to the prejudice of consumers and limiting production, markets and technical development to the prejudice of consumers.
The Act established a new regulatory authority, the COMPETITION COMMISSION, that took over the responsibilities previously undertaken by the Monopolies and Mergers Commission and the Restrictive Practices Court. Under the Act, the OFFICE OF FAIR TRADING (OFT) has the power to refer dominant firm cases and cases of suspected illegal collusion to the Competition Commission for investigation and report.
The Act gives the OFT wide-ranging powers to uncover malpractices. For example, if there are reasonable grounds for suspecting that firms are operating an illegal agreement, OFT officials can mount a ‘dawn raid’ – ‘entering business premises, using reasonable force where necessary, and search for incriminating documents’. The Act also introduces stiff new financial penalties. Firms found to have infringed either prohibitions may be liable to a financial penalty of up to 10% of their annual turnover in the UK (up to a maximum of three years). See COMPETITION POLICY, COMPETITION POLICY (UK), COMPETITION POLICY (EU), ANTICOMPETITIVE AGREEMENT, RESTRICTIVE TRADE AGREEMENT.
Competition Appeals Tribunal (CAT) a body established by the ENTERPRISE ACT 2002 to hear appeals in regard to ‘disputed’ merger cases. The OFFICE OF FAIR TRADING has the power to refer proposed mergers and takeovers to the COMPETITION COMMISSION for investigation if it believes that the merger/takeover would ‘substantially lessen competition’. If, in the OFT’s view, this is not the case, it can allow the merger/takeover to go ahead without reference. This is where the CAT comes in. An interested party (e.g. a competitor of the companies involved in the merger) may ‘appeal’ to the CAT that the OFT decision not to refer is ‘wrong’. The task of the CAT is to arbitrate and decide if there is indeed a case for reference and can ‘order’ a reference