Using the concept of comparative advantage, explain how international trade should allow a country to consume outside its production possibility frontier.
The theory of comparative advantage explains how trade enables an economy to consume more goods than it would in an autarky, where it produces everything domestically without engaging in international trade.
Comparative advantage refers to the ability of a country to produce a particular good or service at a lower opportunity cost compared to other countries. The opportunity cost is the value of the next best alternative that must be given up to produce or consume a specific good or service.
Let's consider Country A and Country B, which both produce two goods: cars and computers. In an autarky scenario, Country A can produce either 100 cars or 200 computers, while Country B can produce either 50 cars or 100 computers.
To determine comparative advantage, we compare the opportunity costs between the two countries. The opportunity cost of producing one car for Country A is 2 computers (200 computers / 100 cars), while for Country B, it is 0.5 computers (100 computers / 50 cars). On the other hand, the opportunity cost of producing one computer for Country A is 0.5 cars (100 cars / 200 computers), and for Country B, it is 1 car (50 cars / 100 computers).
Based on these opportunity costs, we can see that Country A has a comparative advantage in producing computers, as it has a lower opportunity cost (0.5 cars) compared to Country B's opportunity cost of producing computers (1 car). Conversely, Country B has a comparative advantage in producing cars, as it has a lower opportunity cost (0.5 computers) compared to Country A's opportunity cost of producing cars (2 computers).
Now, let's explore the advantages of trade based on these comparative advantages. Suppose Country A specializes in producing computers and allocates all its resources to computer production. Meanwhile, Country B focuses on producing cars and utilizes all its resources for car production.
In this scenario, Country A can produce 400 computers (double its initial production capacity), and Country B can produce 100 cars (double its initial production capacity). If they engage in trade and exchange their surplus goods, both countries can benefit.
Let's assume that through trade, Country A exports 200 computers to Country B and imports 50 cars in exchange. Country B exports 50 cars to Country A and imports 200 computers.
As a result, Country A now has 200 computers for domestic consumption (initial production) plus 200 imported cars, which it did not produce domestically. Similarly, Country B has 50 cars for domestic consumption (initial production) plus 200 imported computers.
Through trade, both countries can consume beyond their initial production possibilities. Country A gains access to cars that it would have struggled to produce domestically, while Country B gains access to computers that would have been costlier to produce locally.
This example demonstrates how trade based on comparative advantage allows countries to allocate resources more efficiently and expand their consumption possibilities. By specializing in the production of goods with lower opportunity costs and engaging in mutually beneficial trade, countries can access a wider variety of goods and achieve a higher level of overall welfare.
It's important to note that the numerical examples used here are for illustrative purposes and simplified for clarity. In real-world scenarios, trade patterns and quantities will vary based on a range of factors, including market conditions, production capacities, and trade policies. Nonetheless, the underlying principle of comparative advantage remains valid in explaining the advantages of trade in expanding consumption possibilities and improving economic welfare.