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Comparative vs Competitive Advantage

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Comparative vs Competitive Advantage Why is it that some regions can produce a product more cheaply than others? What should a region produce? Competitiveness How can ... – PowerPoint PPT presentation

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Title: Comparative vs Competitive Advantage


1
Comparative vs Competitive Advantage
  • Why is it that some regions can produce a product
    more cheaply than others?
  • What should a region produce?

2
Competitiveness
  • How can we define competitiveness of a region
    or location with respect to a particular product
  • What do we mean by competitiveness?

3
Definitions two concepts
  • Comparative advantage
  • Competitiveness

4
Comparative Advantage
  • The issue
  • What is the location best advantaged to produce
    and sell a particular product?

5
Comparative Advantage
  • The issue
  • What is the location best advantaged to produce
    and sell a particular product?
  • Where should biofuel feedstocks be produced?
  • Should the US attempt to compete with India in
    auto production?
  • Should the Federal government try to save Detroit
    but not Georgias auto plants?

6
Comparative Advantage
  • The issue
  • What is the location best advantaged to produce
    and sell?
  • Constraints on the decision spatial distribution
    of
  • Natural conditions and resources
  • Technology available for producing manufactured
    goods
  • Human resources are differentially distributed
  • Social preferences
  • Focus is on resource use

7
Intuition
  • If you have a fixed resource that can be used to
    produce value, how should you use it?

8
What resources might be fixed?
  • Ag land
  • Mineral deposits
  • Educated workforce?
  • Transportation infrastructure?
  • Information technology?
  • We call these nontradables also limited
    resources and because they are located in
    particular region, sometimes called domestic
    resources

9
Opportunity cost and resource use
  • Use the resource such that it produces the
    highest value possible
  • If you chose some other use, the opportunity
    cost of that lower value use would be
  • Opp cost highest value value of your choice
  • Example
  • What is the highest and best use of PAs farm
    land?

10
Comparative advantage
  • Suppose you have two regions with fixed resources
    as follows. What is the comparative advantage of
    each region?
  • Region 1 Located far away from urban population,
    rich ag land.
  • Region 2 Urbanized coastal location with
    deep-water ports, substantial labor force. High
    population density.

11
Definition Comparative Advantage
  • Adam Smith says
  • "What is prudence in the conduct of every private
    family, can scarce be folly in that of a great
    kingdom. If a foreign country can supply us with
    a commodity cheaper than we ourselves can make
    it, better buy it of them with some part of the
    produce of our own industry, employed in a way in
    which we have some advantage. The general
    industry of the country, being always in
    proportion to the capital which employs it, will
    not therby be diminished... but only left to find
    out the way in which it can be employed with the
    greatest advantage."
  • (Adam Smith, The Wealth of Nations, Book IV2,
    Modern Library edition) http//www.wto.org/english
    /res_e/reser_e/cadv_e.htm

12
Boiling it down
  • Locations can produce nearly anything, but what
    would best serve their interests? What would pay
    greatest return on fixed resources?
  • Comparative advantage says two things
  • Produce what you are relatively best at producing
  • Specialize and let others produce your lesser
    advantaged products
  • If a country is relatively better at making wine
    than wool, it makes sense to put more resources
    into wine, and to export some of the wine to pay
    for imports of wool.
  • Because it is relative advantage that matters, it
    is meaningless to say a country has a comparative
    advantage in nothing.

13
Comparative advantage - implications
  • Region 1 Located far away from urban population,
    rich ag land.
  • Region 2 Urbanized coastal location with
    deep-water ports, substantial labor force. High
    population density.
  • Specialize region 1 produces land intensive ag
    products, region 2 produces labor and raw
    material (e.g. ore) intensive manufactured goods.
  • Why does this make sense?

14
What determines Comparative Advantage?
  • If technology diffuses instantaneously across
    geographic space,
  • If there are no fixed or unique resources,
  • why would one region have a particular advantage
    over another?

15
Fixed resources as a basis for advantage?
  • The traditional perspective is
  • Each region specializes and exports products that
    are relatively more intensive in their use of
    fixed resources with which that region is
    endowed.
  • Intuition?

16
Your product
  • Think about your product, what regions have a
    comparative advantage in producing it?
  • Why?

17
How can we measure comparative advantage?
  • Comparison of
  • productivity
  • costs of production ltltprice
  • profitability?
  • The idea was to find intrinsic relative
    advantage, but how can we do that without looking
    at prices, institutions, etc?

18
Old school approach to comparative advantage
  • Does Senegal have a comparative advantage in rice
    production?
  • Should the World Bank grant a loan for
    development of rice production to Senegal?
  • How could we analyze quantitatively Senegals
    comparative advantage?
  • New concept domestic resource cost (DRC)
  • DRC compares price of importing rice to cost of
    producing it in the country. Cost includes
    opportunity cost of using scarce resources.

19
DRC intuition
  • Suppose a product like rice is produced using
  • Fixed domestic resources
  • Tradable inputs
  • Suppose the product could be imported.
  • DRC compares the opportunity cost of using fixed
    domestic resources to product it vs. net value
    created from tradables.

20
DRC calculation
  • Domestic fixed (nontradable) resources
  • Yd quantity used to produce a product, e.g.
    rice
  • Pd opportunity cost of using Yd
  • Product to be produced (e.g. rice)
  • Yo quantity producible with Yd Po border
    price of Yo
  • Tradable goods used
  • YT quantity used PT price
  • DRC Pd Yd / Po Yo - PT YT
  • value of limited resources
    used/value-added created
  • 1/rate of return to limited resources

21
Using the DRC to evaluate comparative advantage
  • DRC Pd Yd / Po Yo - PT YT
  • So, product Y has a comparative advantage if
  • DRC Pd Yd / Po Yo - PT YT 1/rate of
    return lt 1
  • In practice, you compute DRCs for a set of
    possible uses of the domestic resources, the best
    use is that which provides the lowest DRC ?
    highest rate of return to use of domestic fixed
    resources.

22
Opportunity cost of using the fixed resource?
  • DRC Pd Yd / Po Yo - Pt Yt
  • How could we measure Pd Yd ??
  • Next highest value of alternative use of the
    resource.
  • Rice or what? Peanuts? Cassava?

23
DRC use
  • Type of social valuation of cost vs. benefit of
    producing vs. importing
  • Senegal rice - Thai broken imports are cheap,
  • Senegal has ag land with potential, should it
    produce rice or something else?

24
Critique of comparative advantage
  • Today, many of the resources that were once
    thought of as nontradable are in fact tradable.
  • Technology that once provided advantage to one
    country or region, is now easily tradable.
  • What might be the basis of comparative advantage?
  • If useful, we must recognize comparative
    advantage changes over time, today that change is
    rapid.

25
Competitiveness, a better measure?
  • Michael Porters book
  • Plain old economic sense
  • If the economic environment is taken as given,
  • what can a location most profitably produce ?
  • how can it create greatest value from its
    resources?
  • Definition A location is relatively competitive
    in a product if it can profitably produce and
    market it.
  • Competitiveness is a much broader concept than
    comparative advantage.

26
Competitiveness
  • Focus is on profitability
  • Considers
  • Fixed resources
  • But also,
  • Strategic capability of achieving and maintaining
    profits.
  • Depends on use of technology, tradable and
    nontradable inputs!

27
Implications
  • Locate production where it is most profitable.
  • Critique
  • We want an indicator of persistent relative
    advantage, can we use price related measures when
    prices are institutionally, socially, and
    politically affected?

28
Interest in competitiveness
Nearly every region and country is looking for
its competitive advantage. Google
competitiveness your favorite region or
nation Example
  • http//www.competitiveturkey.org/version3/catentr.
    html

29
Appendix Details on DRC
  • For the brave at heart..

30
Back to our notation in profits.
We define profits as return to fixed inputs,
Suppose we define the opportunity cost of using
the fixed, local (domestic) resources as
involving multiple domestic resources
31
Back to our notation in profits.
Domestic resource cost compares value created to
opportunity cost of use of resources
We argue location i has competitive advantage in
good 1 if
32
How to measure..
We measure profits based on border prices for
variable cost and revenue
we define the opportunity cost of using these
fixed, local, or domestic resources Z as r, the
highest value next use
33
Bottomline
  • For any case where we have a fixed or limited
    resource, we can examine competitiveness.
  • Labor force.what is its comparative advantage
  • Fixed resource is its current educational
    attainment, knowledge, skills.
  • What is its best use?
  • Region.shale deposits under ag land what is
    best use of surface ?
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