Question

The Discussion topics include the difference between microeconomics and macroeconomics, the two basic economic models of the Circular-Flow Diagram and the Production Possibility Frontier, and comparative advantage, which is the main force behind interdependence in the market economy and the gains from trade.

Read Chapters 2 and 3, and remember to include references and links to the websites that are important contributors to your posts.

The theory of comparative advantage states that there are gains from trade if countries specialize and optimize their opportunity costs.

1. Why is comparative advantage a driving force behind trade behind trade between regions and countries?
2. Why does specialization lead to welfare improvement? Why engaging in trade is better than trying to be self-sufficient?

Answer 1

a) Comparative advantage is a concept that is derived from opportunity cost of production . The amount of good or service that is sacrificed to produce another good or service is termed as opportunity cost . Now a country may have absolute advantage in every good and service , that is , a country can produce more of every good . But a country cannot have comparative advantage in every good it produces since comparative advantage is a relative term . The country with comparatively lower opportunity cost has a comparative advantage in production from another country . So if country A has a comparative advantage in producing X , country B will definitely have advantage in producing good Y because this is a relative comparative term . It determines efficiency of production and not merely volume of production .

So if a country specializes in that good in which it has comparative advantage it can produce more with less resources and after exchanging the surplus with other countries can raise their consumption point . So comparative advantage leads to specialization . Since a country cannot thrive by just producing 1 good , so this leads to exchange or trade between regions . Thus , this rise in consumption point is called gains from trade .

b) As discussed above specialization as per efficiency or comparative advantage leads to more overall world output . This surplus determines world price and trade . So after trade the consumption point rises , a country can consume outside its production possibility frontier after specialization and trade . Hence it leads to welfare improvement .