In order for mutually beneficial trade to occur by chance
What happens to the possibilities for trade if one country has an absolute advantage in everything? This is typical for high-income countries that in order for mutually beneficial trade to occur by chance have well-educated workers, technologically advanced equipment, and the most up-to-date production processes.
These high-income countries can produce all products with fewer resources than a low-income country. If the high-income country is more productive across the board, will there still be gains from trade? Good students of Ricardo understand that trade is about mutually beneficial exchange. Even when one country has an absolute advantage in all products, trade can still benefit both sides. In this example, it takes four U. It takes one U. The United States has an absolute advantage in productivity with regard to both shoes and refrigerators; that is, it takes fewer workers in the United States than in Mexico to produce both a given number of shoes and a given number of refrigerators.
The United States can produce 1, shoes with four-fifths as many workers as Mexico four versus fivebut it can produce 1, refrigerators with only one-quarter as many workers one versus four. When nations increase production in their area of comparative advantage and trade with each other, both countries can benefit. Again, the production possibility frontier is a useful tool to visualize this benefit.
Consider a situation where the United States and Mexico each have 40 workers. If four workers can make 1, shoes, then 40 workers will make 10, shoes. If the 40 workers in the United States are making refrigerators, and each worker can produce 1, refrigerators, then a total of 40, refrigerators will be produced. Continuing with this scenario, each country transfers some amount of labor toward its area of comparative advantage.
For example, the United States transfers six workers away from shoes and toward producing refrigerators. As a result, U. Mexico also moves production toward its area of comparative advantage, transferring 10 workers away from refrigerators and toward production of shoes. The reduction of shoe production by 1, pairs in the United States is more than offset by the gain of 2, pairs of shoes in Mexico, while the reduction of 2, refrigerators in Mexico is more than offset by the additional 6, refrigerators produced in the United States.
This numerical example illustrates the remarkable insight of comparative advantage: Even though the United States has an absolute advantage in producing both refrigerators and shoes, it makes economic sense for it to specialize in the good for which it has a comparative advantage. The United States will export refrigerators and in return import shoes. This example shows that both parties can benefit from specializing in their comparative advantages and trading.
By using the opportunity costs in this example, it is possible to identify the range of possible trades that would benefit each country. Then, in the numerical example given, Mexico shifted production toward its comparative advantage and produced 6, pairs of shoes but only 2, refrigerators. Mexico will be unambiguously better off. Conversely, the United States started off, before specialization and trade, producing 5, pairs of shoes and 20, refrigerators. In the example, it then shifted production toward its comparative advantage, producing only 3, shoes but 26, refrigerators.
If the United States can export no more than 6, refrigerators in in order for mutually beneficial trade to occur by chance for imports of at least 1, pairs of shoes, it will be able to consume more of both goods and will be unambiguously better off. For example, a trade where the U. Trade allows each country to take advantage of lower opportunity costs in the other country.
If Mexico wants to produce more refrigerators without trade, it must face its domestic opportunity costs and reduce shoe production. Conversely, when the United States specializes in its comparative advantage of refrigerator production and trades for shoes produced in Mexico, international trade allows the United States to take advantage of the lower opportunity cost of shoe production in Mexico. The theory of comparative advantage explains why countries trade: It shows that the gains from international in order for mutually beneficial trade to occur by chance result from pursuing comparative advantage and producing at a lower opportunity cost.
In Canada a worker can produce 20 barrels of oil or 40 tons of lumber. In Venezuela, a worker can produce 60 barrels of oil or in order for mutually beneficial trade to occur by chance tons of lumber. To calculate absolute advantage, look at the larger of the numbers for each product. One worker in Canada can produce more lumber 40 tons versus 30 tonsso Canada has the absolute advantage in lumber.
One worker in Venezuela can produce 60 barrels of oil compared to a worker in Canada who can produce only To calculate comparative advantage, find the opportunity cost of producing one barrel of oil in both countries. The country with the lowest opportunity cost has the comparative advantage.
With the same labor time, Canada can produce either 20 barrels of oil or 40 tons of lumber. So in effect, 20 barrels of oil is equivalent to 40 tons of lumber: Divide both sides of the equation by 20 to calculate the opportunity cost of one barrel of oil in Canada.
To produce one additional barrel of oil in Canada has an opportunity cost of 2 lumber. Calculate the same way in order for mutually beneficial trade to occur by chance Venezuela: Divide both sides of the equation by Calculate the opportunity cost of one lumber by reversing the numbers, with lumber on the left side of the equation.
In Canada, 40 lumber is equivalent in labor time to 20 barrels of oil: Divide each side of the equation by In Venezuela, the equivalent labor time will produce 30 lumber or 60 oil: Divide each side by One lumber has an opportunity cost of two oil. Canada has the lower opportunity cost in producing lumber. In this example, absolute advantage is the same as comparative advantage. Canada has the absolute and comparative advantage in lumber; Venezuela has the absolute and comparative advantage in oil.
Canada should specialize in what it has a relative lower opportunity cost, which is lumber, and Venezuela should specialize in oil. Canada will be exporting lumber and importing oil, and Venezuela will be exporting oil and importing lumber.
To build an intuitive understanding of how comparative advantage can benefit all parties, set aside examples that involve national economies for a moment and consider the situation of a group of friends who decide to go camping together. The six friends have a wide range of skills and experiences, but one person in particular, Jethro, has done lots of camping before and is also a great athlete. Jethro has an absolute advantage in all aspects of camping: So here is the question: Because Jethro has an absolute productivity advantage in everything, should he do all the work?
Even if Jethro is willing to work like a mule while everyone else sits around, he, like most mortals, only has 24 hours in a day.
If everyone sits around and waits for In order for mutually beneficial trade to occur by chance to do everything, not only will Jethro be an unhappy camper, but there will not be much output for his group of six friends to consume. The theory of comparative advantage suggests that everyone will benefit if they figure out their areas of comparative advantage—that is, the area of camping where their productivity disadvantage is least, compared to Jethro.
In that case, Jethro should focus on building fires and making meals, and others should attend to the other tasks, each according to where their productivity disadvantage is smallest. If the campers coordinate their efforts according to comparative advantage, they can all gain. Even when a country has high levels of productivity in all goods, it can still benefit from trade. Gains from trade come about as a result of comparative advantage. By specializing in a good that it gives up the least to produce, a country can produce more and offer in order for mutually beneficial trade to occur by chance additional output for sale.
If other countries specialize in the area of their comparative advantage as well and trade, the highly productive country is able to benefit from a lower opportunity cost of production in other countries.
In Germany it takes three workers to make one television and four workers to make one video camera. In Poland it takes six workers to make one television and 12 workers in order for mutually beneficial trade to occur by chance make one video camera. Germany has an absolute advantage in the production of both goods.
Thus, the opportunity cost of producing televisions is lower in Poland, so Poland has the comparative advantage in the production of televisions. If either country was to expand television production by a significant amount—that is, lots more than one unit—then we will be talking about whole cameras and not fractional ones.
Producing a video camera in Poland requires 12 workers, and shifting those 12 workers away from television production has an opportunity cost of two television sets. Germany has the absolute advantage in the production of both goods, but Poland has a in order for mutually beneficial trade to occur by chance advantage in the production of televisions.
Conversely, Poland should specialize, in order for mutually beneficial trade to occur by chance least to some extent, in the production of televisions, export televisions, and import video cameras.
Is it possible to have a comparative advantage in the production of a good but not to have an absolute advantage? You just overheard your friend say the following: They have poor soil, low investments in formal education and hence low-skill workers, no capital, and no natural resources to speak of. Because they have no advantage, they cannot benefit from trade. Is there a range of trades for which there will be no gains? You just got a job in Washington, D.
You move into an apartment with some acquaintances. All your roommates, however, are slackers and do not clean up after themselves. You, on the other hand, can clean faster than each of them. All of these tasks have to be done daily. Which jobs should you assign to your roommates to get the most free time overall?
Assume you have the same number of hours to devote to cleaning. Now, since you are faster, you seem to get done quicker than your roommate. What sorts of problems may this create? Can you imagine a trade-related analogy to this problem? In Japan, one worker can make 5 tons of rubber or 80 radios. In Malaysia, one worker can make 10 tons of rubber or 40 radios.
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