Comparative Advantage and Gains from Trade
| English | Chinese | Pinyin |
|---|---|---|
| trade | 贸易 | mào yì |
| specialise | 专业化 | zhuān yè huà |
| 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 |
| terms of trade | 贸易条件 | mào yì tiáo jiàn |
Why trade if you're better at everything?
- Suppose your country can make more of every good than your neighbour.
- It sounds like you should just make everything yourself.
- Yet both countries end up richer if they each specialise and then trade.
- The reason is one of the most surprising ideas in all of economics: comparative advantage 比较优势.
Absolute vs comparative advantage
- Absolute advantage 绝对优势 means making more of a good with the same resources.
- Comparative advantage 比较优势 means having the lower opportunity cost 机会成本 of making it.
- These are not the same: one producer 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 should specialise.
A country has an absolute advantage in a good when it can:
Absolute advantage is about raw output; comparative advantage is about opportunity cost.
Work out who should make what
- Worked example. In one day: Country X can make 10 phones or 20 shirts; Country Y can make 4 phones or 4 shirts.
- X's opportunity cost of 1 phone is $20/10 = 2$ shirts; Y's is $4/4 = 1$ shirt.
- Y gives up fewer shirts per phone, so Y should make the phones.
- Checking shirts: X gives up $10/20 = 0.5$ phones each, Y gives up $1$ — so X should make the shirts.
X: 10 phones or 20 shirts. Y: 4 phones or 4 shirts. Who has the comparative advantage in phones?
Y gives up 1 shirt per phone vs X's 2 shirts — Y has the lower opportunity cost.
Country X can make 10 phones OR 20 shirts in a day. What is the opportunity cost of ONE phone, in shirts?
Giving up 20 shirts frees enough to make 10 phones, so each phone costs $20/10 = 2$ shirts.
Specialise, then trade
- Each producer specialises 专业化 in the good where its opportunity cost is lower.
- They then trade 贸易 for the rest, and both can consume beyond their own PPC.
- The terms of trade 贸易条件 (the swap rate) must sit between the two opportunity costs for both sides to gain.
- Remember: X was absolutely better at both goods, yet trade still made both better off.
If one country is better at making every good, trade cannot benefit both sides.
As long as opportunity costs differ, both gain from specialising and trading — even then.
A producer should ______ in the good where it has a comparative advantage.
Specialise where your opportunity cost is lowest, then trade for the rest.
Select all true statements about gains from trade.
Both sides gain when they specialise by comparative advantage and trade at terms between their opportunity costs.
Comparative advantage is the lower opportunity cost — not making more (that is absolute advantage). Each producer should specialise where its opportunity cost is lower and trade for the rest. This works even if one producer is better at everything, and lets both consume beyond their own PPC.