The Fundamentals of Economics

Trade allows for specialization. Specialization enables countries (and people) to spend their time doing what they do best. The United States is capable of flooding the marketplace with clothing. However, the vast majority of clothing is made in other countries. The United States chooses to specialize in other areas, such as making movies.

• Absolute advantage – the producer requires the least amount of resources or can produce the most output.
• Comparative advantage – the producer has the lowest opportunity cost.

A country should specialize in trade when it has comparative advantage. The United States has an absolute advantage in clothing and a comparative advantage in movies.

There is a significant benefit to trade between countries. Given the available resources, a country can consume more of a particular item than if it produces that item on its own. For example, the United States doesn’t have the resources to produce the amount of clothing that consumers currently buy.

Two countries can benefit from trade if they each have relatively lower opportunity costs. There are never trade benefits in every term. Each country negotiates conditions of trade until the countries make a deal that benefits both of them. The terms of trade measure the rate of exchange of one product for another.

To figure out comparative advantage, per unit opportunity cost is calculated. There are two types of questions: output and input.

Output is the number of units produced. The United States has an absolute advantage in the production of airplanes and vehicles in the example below. In this instance, Canada should trade airplanes for vehicles from the United States since the most units (1,500) are produced with this trade (50 x 30). Canada has comparative advantage in airplane production, and the United States has comparative advantage in vehicle production.