Economics Essay 71: Theories of Trade

Explain, using numerical examples, the difference between comparative and absolute advantage in trade. 

Let's use numerical examples to illustrate the difference between comparative and absolute advantage in trade:

Comparative Advantage: Comparative advantage refers to the ability of a country, individual, or firm to produce a good or service at a lower opportunity cost compared to others. It is about relative efficiency rather than absolute efficiency. To understand this concept, let's consider the example of two countries: Country A and Country B.

Assume that Country A can produce either 100 units of wheat or 50 units of cloth, while Country B can produce either 80 units of wheat or 40 units of cloth. The opportunity cost is calculated by dividing the quantity of one good given up to produce another. The opportunity cost of producing 1 unit of wheat in Country A is 0.5 units of cloth (100/50), while in Country B, it is 0.5 units of cloth as well (80/40).

In this case, Country A has a lower opportunity cost of producing wheat compared to Country B (0.5 units of cloth vs. 1 unit of cloth). Therefore, Country A has a comparative advantage in producing wheat, while Country B has a comparative advantage in producing cloth. According to the principle of comparative advantage, both countries can benefit from specialization and trade. Country A can specialize in producing wheat and export it to Country B, while Country B can specialize in producing cloth and export it to Country A.

Absolute Advantage: Absolute advantage, on the other hand, refers to the ability of a country, individual, or firm to produce more output with the same resources compared to others. It is about being more efficient in terms of productivity. To illustrate this concept, let's consider an example between Country X and Country Y.

Assume that Country X can produce 100 units of cars or 200 units of bicycles, while Country Y can produce 80 units of cars or 120 units of bicycles. In this case, Country X has an absolute advantage in both car production (producing more cars) and bicycle production (producing more bicycles) compared to Country Y.

While Country X has an absolute advantage in both goods, it doesn't necessarily mean that there is no room for trade based on comparative advantage. Even though Country X can produce more cars and bicycles, if the opportunity cost of producing one good is lower for Country Y (i.e., it gives up fewer units of the other good), it would still make sense for both countries to specialize and trade.

In summary, comparative advantage is based on the concept of lower opportunity cost, where a country focuses on producing the goods with a lower opportunity cost compared to other countries. Absolute advantage, on the other hand, is based on producing more output with the same resources. Both concepts play a role in determining trade patterns and the benefits of specialization and trade between countries.

A Level Economics Essay 23: Comparative Advantage and Trade

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.

Bad Samaritans, The Myth of Free Trade and the Secret History of Capitalism by Ha Joon Chang, AudioBook

 

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A Level Macroeconomics 2 - AQA - International Economics

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