Comparative Advantage and Gains from Trade
| English | Chinese | Pinyin |
|---|---|---|
| comparative advantage | 比较优势 | bǐ jiào yōu shì |
| absolute advantage | 绝对优势 | jué duì yōu shì |
| opportunity cost | 机会成本 | jī huì chéng běn |
| specialise | 专业化 | zhuān yè huà |
| terms of trade | 贸易条件 | mào yì tiáo jiàn |
Why nations trade at all
- If a country could make everything more cheaply, why buy from abroad?
- Yet even then, trade leaves both countries better off.
- The reason is one of the most powerful ideas in economics.
- It rests on comparative advantage 比较优势, not on being best at everything.
Absolute vs comparative advantage
- Absolute advantage 绝对优势 means making more of a good with the same resources.
- Comparative advantage means having the lower opportunity cost 机会成本 of making it.
- A country can hold the absolute advantage in everything, yet the comparative advantage in only some things.
- For trade, the rule that matters is comparative, not absolute.
Absolute or comparative?
Absolute advantage is about making more; comparative advantage is about the lower opportunity cost. Only comparative advantage decides who specialises.
A country has a comparative advantage in a good when it has:
Comparative advantage is about opportunity cost, not raw output.
Work out who makes what
- Worked idea. In a day, Country A makes 12 wheat or 6 cloth; Country B makes 4 wheat or 4 cloth.
- A's opportunity cost of 1 cloth is $12/6 = 2$ wheat; B's is $4/4 = 1$ wheat — so B has the comparative advantage in cloth.
- A's cost of 1 wheat is $6/12 = 0.5$ cloth; B's is 1 cloth — so A has the comparative advantage in wheat.
A: 12 wheat or 6 cloth. B: 4 wheat or 4 cloth. Who has the comparative advantage in cloth?
B gives up 1 wheat per cloth vs A's 2 — B has the lower opportunity cost in cloth.
Country A makes 12 wheat OR 6 cloth in a day. What is the opportunity cost of ONE cloth, in wheat?
Giving up 12 wheat frees enough to make 6 cloth, so each cloth costs $12/6 = 2$ wheat.
Specialise, then trade
- Each country specialises 专业化 where its opportunity cost is lower (A in wheat, B in cloth).
- They then trade, and both consume beyond their own PPC.
- The terms of trade 贸易条件 must fall between the two opportunity costs for both to gain.
- This holds even though one country may be absolutely better at everything.
If one country is absolutely better at making everything, trade cannot benefit both.
As long as opportunity costs differ, both gain from specialising and trading.
Each country should ______ in the good where its opportunity cost is lower.
Specialise by comparative advantage, then trade for the rest.
For both countries to gain, the terms of trade must lie:
A swap rate between the two costs leaves both better off than in isolation.
Comparative advantage is the lower opportunity cost — not making more (that is absolute advantage). Each country should specialise where its opportunity cost is lower and trade for the rest, gaining even if one is better at everything. The terms of trade sit between the two opportunity costs.