Question

A.Identify and explain the relationships among these concepts: comparative advantage, specialization and trade.

(B) Discuss the benefits and costs of specialization and trade. Do this for both individuals and countries

Answer 1

A. 1.This section lays the foundation for why countries and individual gain from trade countries usually trade to buy goods that are produced at the lower cost elsewhere .Countries and people have different cost of production or different abilities in producing goods .They can take advantage of the differences in order to make themselves better off . When they do this ,they experience gain from trade.

Comparative advantage-

In economics, comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. Even if one country is more efficient in the production of all goods (has an absolute advantage in all goods) than another, both countries will still gain by trading with each other. More specifically, countries should import goods if the opportunity cost of importing is lower than the cost of producing them locally.

Specialization according to comparative advantage results in a more efficient allocation of world resources. Larger outputs of both products become available to both nations. The outcome of international specialization and trade is equivalent to a nation having more and/or better resources or discovering improved production techniques.

Relationship between specialization and trade.

Comparative advantage is the driving force of specialization and trade.

Specialization refers to the tendency of countries to specialize in certain products which they trade for other goods, rather than producing all consumption goods on their own. Countries produce a surplus of the product in which they specialize and trade it for a different surplus good of another country. The traders decide on whether they should export or import goods depending on comparative advantages.

Imagine that there are two countries and both countries produce only two products. They can both choose to be self-sufficient, because they have the ability to produce both products. However, specializing in the product for which they have a comparative advantage and then trading would allow both countries to consume more than they would on their own.

One might assume that the country that is most efficient at the production of a good would choose to specialize in that good, but this isn’t always the case. Rather than absolute advantage, comparative advantage is the driving force of specialization. When countries decide what products to specialize in, the essential question becomes who could produce the product at a lower opportunity cost. Opportunity cost refers to what must be given up in order to obtain some item. It requires calculating what one could have gotten if one produced another product instead of one unit of the given product.

The realatirelat among these is : A country can specialize in producing that for which it has a comparative advantage and then trade for other needed goods and services.

B.

Specialization

Production specialization according to comparative advantage, not absolute advantage, results in exchange opportunities that lead to consumption opportunities beyond the PPC. Trade between two agents or countries allows the countries to enjoy a higher total output and level of consumption than what would have been possible domestically.

Canada and Mexico can each specialize in the good they have a comparative advantage in and exchange with one another. This lets both countries enjoy more maple syrup and avocados than they could have enjoyed without trade. Mexico will export avocados and import maple syrup; this way Mexicans can enjoy their tasty breakfasts and Canadians will enjoy delicious guacamole!

Comparative advantage and opportunity costs determine the terms of trade for exchange under which mutually beneficial trade can occur.

In order for Canadians to benefit from trade with Mexico, they must be able to import avocados at a lower opportunity cost than it would cost them to grow domestically. Likewise, Mexico must get maple syrup more cheaply (in terms of avocados given up) than it could have produced it for domestically. The terms of trade refer to the trading price agreed upon by two agents, which when beneficial, will allow both countries to enjoy gains from trade.