The reasons for international trade
Why countries trade
- International trade lets each country specialise in what it makes best, so the world makes more.
- absolute advantage — make more of a good with the same resources.
- comparative advantage — make a good at a lower opportunity cost.
Practice
A country has a comparative advantage in a good if it can make it at a:
Comparative advantage is about the lowest opportunity cost; absolute advantage is about more output.
Comparative advantage
- The key idea: make the goods you give up least to produce, and trade for the rest.
- Even a country that's better at both goods gains by specialising where its opportunity cost is lowest.
- The terms of trade = export prices vs import prices; they "improve" when export prices rise faster.
Practice
A country that is better at producing both goods can still gain from trade by specialising.
Even with absolute advantage in both, specialising where opportunity cost is lowest lets both countries gain.
Practice
The terms of trade improve when:
Improving terms of trade means the country can buy more imports for the same exports.
You've got it
Key idea
- trade lets countries specialise → the world produces more
- absolute advantage = more output; comparative advantage = lower opportunity cost
- both countries gain by specialising in their comparative advantage, then trading