Compare with the original production matrix

Pre-Specialisation	CD Players	Personal Computers
UK	2,000
Japan	4,000	2,000
Total Output	6,000	2,500

After trade has taken place, total output of goods available to consumers in both countries has grown. UK's consumption of CD players has increased by 200 and they have an extra 100 PCs. For Japan, they have an extra 200 CD players and 200 PCs.

Assumptions underlying the concept of comparative advantage

• Perfect occupational mobility of factors of production - resources used in one industry can be switched into another without any loss of efficiency
• Constant returns to scale (i.e. doubling the inputs in each country leads to a doubling of total output)

· No externalities arising from production and/or consumption

· Transportation costs are ignored

If businesses exploit increasing returns to scale (i.e. economies of scale) when they specialise, the potential gains from trade are much greater. The idea that specialisation should lead to increasing returns is associated with economists such as Paul Romer and Paul Ormerod

What determines comparative advantage?

Comparative advantage is a dynamic concept. It can and does change over time. Some businesses find they have enjoyed a comparative advantage in one product for several years only to face increasing competition as rival producers from other countries enter their markets.

For a country, the following factors are important in determining the relative costs of production:

· The quantity and quality of factors of production available (e.g. the size and efficiency of the available labour force and the productivity of the existing stock of capital inputs). If an economy can improve the quality of its labour force and increase the stock of capital available it can expand the productive potential in industries in which it has an advantage.

· Investment in research & development (important in industries where patents give some firms significant market advantage) - for more information on this have a look at this page

· Movements in the exchange rate. An appreciation of the exchange rate can cause exports from a country to increase in price. This makes them less competitive in international markets.

· Long-term rates of inflation compared to other countries. For example if average inflation in Country X is 4% whilst in Country B it is 8% over a number of years, the goods and services produced by Country X will become relatively more expensive over time. This worsens their competitiveness and causes a switch in comparative advantage.

· Import controls such as tariffs and quotas that can be used to create an artificial comparative advantage for a country's domestic producers- although most countries agree to abide by international trade agreements.

· Non-price competitiveness of producers (e.g. product design, reliability, quality of after-sales support)