Question

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3. What is comparative advantage, and why is it important in international trade? Reference: Explanation: Comparative advantage states that aggregate output is maximized when countries specialize in the production of goods for which they are the lowest opportunity cost producer, and then trade for other goods. This explains how countries can improve their situation through trade, rather than producing all goods themselves.

Answer 1

Comparative advantage is the idea that countries can have an advantage over others with respect to the production of a particular good in relation to their production of other goods, even if it is costlier for them to produce all goods in an absolute sense. If each country specializes in the production of goods for which they have a comparative advantage, the countries can trade with one another to achieve greater results than any could on their own.

Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. Opportunity cost measures a trade-off. A nation with a comparative advantage makes the trade-off worth it. The benefits of buying their good or service outweigh the disadvantages. The country may not be the best at producing something. But the good or service has a low opportunity cost for other countries to import.

For example, oil-producing nations have a comparative advantage in chemicals. Their locally-produced oil provides a cheap source of material for the chemicals when compared to countries without it. A lot of the raw ingredients are produced in the oil distillery process. As a result, Saudi Arabia, Kuwait, and Mexico are competitive with U.S. chemical production firms. Their chemicals are inexpensive, making their opportunity cost low.

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

Another example is India's call centers. U.S. companies buy this service because it is cheaper than locating the call center in America. Indian call centers aren't better than U.S. call centers. Their workers don't always speak English very clearly. But they provide the service cheaply enough to make the tradeoff worth it.

In the past, comparative advantages occurred more in goods and rarely in services. That's because products are easier to export. But telecommunication technology like the internet is making services easier to export. Those services include call centers, banking, and entertainment.