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According to Adam Smith, countries with an absolute advantage in the production of particular products should specialize in the production of that particular product. But according to David Ricardo, specialization should be done based on the opportunity cost of production. This model is called comparative advantage. It is better to specialize using comparative advantage as total production will be higher than using absolute advantage.

I have chosen this video because this video simplified the topic by using a story and a simple example on an island. I want to use this video to open discussion on this topic without complicated graphs and data.

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Episode 34: Comparative Advantage & Trade

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This video starts with an example of a person who exchanged a pin with a house. He explains absolute advantage, comparative advantage and the terms of trade in this video using squares and triangles. Absolute advantage is the advantage that one has over others in a particular product in a production possibility curve. Whereas Comparative advantage is the advantage that one has over others in respect to the opportunity cost of that production. The terms of trade are the range of possible exchange rates where both parties would benefit.

I have selected this video as this video explains terms of trade which is very crucial in understanding this concept by using graphs.

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Comparative Advantage and Trade - Macro Topic 1.3 (Micro Topic 1.4)

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This video explains how specialization and trade benefit both parties using comparative advantage, even without absolute advantage. Here South Korea has a comparative advantage in smartphone production and the USA has a comparative advantage in the production of apples. Here if both countries specialize in the product that they have a comparative advantage and trade with each other, they can consume more than the actual production possibilities curve can offer without trade. But this will depend on the terms of trade that they can agree upon.

I have chosen this video, as this is a real-world application of knowledge on international trade.

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The Gains from International Trade in the PPC Model

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In this video, she explains the importance of the size of the trade. Even though the trade is beneficial to both parties, It is important for the trade to be of optimal size to benefit both parties. Here she explains how this is important when both of the parties specialize, but the size of the trade is small. In this scenario, we may have an imbalance in the products.

I have used this video over other videos because I want to explain that there may be a downside if we specialize and completely rely on trade to satisfy our needs. For example, recently a ship blocking the Suez Canal led to a shortage of products in Europe.

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Comparative Advantage and Gains From Trade - The Size of a Trade

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This is concise information on the topic of comparative advantage and gains from trade. In this topic, We can understand the reasons for the trade, benefits of trade and the factors dictating the trade concerning comparative advantage.

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This is in-depth information about international trade and explains how Canada and the international economy are intertwined. It also explains the importance of international trade to the Canadian economy. explains comparative advantage and how this comparative advantage arises due to climate, labor availability of resources capital Technology and external economies. It explains how international trade increases consumption. Even though it explains the importance it also explains why total specialization cannot occur using opportunity cost tests etc. it States who are the losers and winners of international trade. This has a very good explanation about the rise and fall of North American manufacturing in terms of comparative advantage.

This document has lot of information. It is well written. every one should read this to gain insight into international trade in Canadian perspective.

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This starts with Benjamin Franklin's statement " no Nation was ever ruined by trade". This explains why attitudes towards international trade should be positive with some evidence. It exemplifies the growth of Japan, South Korea and India after opening to international trade. It also states that no modern country was able to prosper by restricting trade. It further explains the reason behind this prosperity is due to comparative advantage inside. It further explains absolute advantage and comparative advantage. It also includes a few questions to check our understanding.

I have chosen this website as this has questions to check our understanding.

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Learning Objectives

Explain absolute advantage and comparative advantage

Absolute and Comparative Advantage

The American statesman Benjamin Franklin (1706-1790) once wrote: "No nation was ever ruined by trade." Many economists would express their attitudes toward international trade in an even more positive manner. The evidence that international trade confers overall benefits on economies is pretty strong. Trade has accompanied economic growth in the United States and around the world. Many of the national economies that have shown the most rapid growth in the last few decades-for example, Japan, South Korea, China, and India-have done so by dramatically orienting their economies toward international trade. There is no modern example of a country that has shut itself off from world trade and yet prospered. To understand the benefits of trade, or why we trade in the first place, we need to understand the concepts of comparative and absolute advantage.

In 1817, David Ricardo, a businessman, economist, and member of the British Parliament, wrote a treatise called On the Principles of Political Economy and Taxation. In this treatise, Ricardo argued that specialization and free trade benefit all trading partners, even those that may be relatively inefficient. To see what he meant, we must be able to distinguish between absolute and comparative advantage.

A country has an absolute advantage over another country if it can produce a given product using fewer resources than the other country needs to use. For example, if Canada can produce 100 pounds of beef using two ranchers, while Argentina needs three ranchers to produce 100 pounds of beef, Canada has an absolute advantage over Argentina in beef production.

Absolute advantage can be the result of a country's natural endowment. For example, extracting oil in Saudi Arabia is pretty much just a matter of "drilling a hole." Producing oil in other countries can require considerable exploration and costly technologies for drilling and extraction-if indeed they have any oil at all. The United States has some of the richest farmland in the world, making it easier to grow corn and wheat than in many other countries. Guatemala and Colombia have climates especially suited for growing coffee. Chile and Zambia have some of the world's richest copper mines. As some have argued, "geography is destiny." As a result, it should not be surprising if Chile provides copper to Guatemala, while Guatemala provides coffee to Chile. When each country has a product others need and it can be produced with fewer resources in one country over another, then it is easy to imagine all parties benefitting from trade. However, thinking about trade just in terms of geography and absolute advantage is incomplete. What happens if one country has an absolute advantage in both goods? Trade really occurs because of comparative advantage.

A country has a comparative advantage when it can produce a good at a lower opportunity cost than another country. The question each country or company should be asking when it trades is this: "What do we give up to produce this good?" For example, if Zambia produces copper, the resources it uses cannot be used to produce other goods such as corn. As a result, Zambia gives up the opportunity to produce corn. Suppose it takes 10 hours of labor to mine a ton of copper in Zambia, and 20 hours of labor to harvest a bushel of corn. This means the opportunity cost of producing a ton of copper is 2 bushels of corn. The next section develops absolute and comparative advantage in greater detail and relates them to trade.

Watch It

Watch the following video to better understand comparative advantage.

You can view the transcript for "Episode 34: Comparative Advantage & Trade" here (opens in new window).

What Happens When a Country Has an Absolute Advantage in All Goods

What happens to the possibilities for trade if one country has an absolute advantage in everything? This is typical for high-income countries that often have well-educated workers, technologically advanced equipment, and the most up-to-date production processes. These high-income countries can produce all products with fewer resources than a low-income country. If the high-income country is more productive across the board, will there still be gains from trade? Good students of Ricardo understand that trade is about mutually beneficial exchange. Even when one country has an absolute advantage in all products, trade can still benefit both sides. This is because gains from trade come from specializing in one's comparative advantage.

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Explain absolute advantage and comparative advantage The American statesman Benjamin Franklin (1706-1790) once wrote: "No nation was ever ruined by trade." Many economists would express their attitudes toward international trade in an even more positive manner. The evidence that international trade confers overall benefits on economies is pretty strong.

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This photo illustrates how sufficient societies produce less than a trading society by using mathematical formulas. In the first case, the country was self-sufficiently allocating resources to produce 45 units. whereas in the second case countries were trading and produced 51 units

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This image shows two scenarios. In the first scenario, either Mary or Tom has an absolute advantage over each other. Whereas in the second case only Tom has an absolute advantage, but Mary has a relative advantage in grapes.

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This website explains the history of comparative advantage. It states that protectionism is unnecessary and free trade is important. it explains that absolute advantage is not always required to benefit from A trade. trading can make products better faster and cheaper for both partners. It explains that a country should specialize in products that have a comparative advantage with an example. it further explains free trade policies and their advantages. it further explains why complete free trade is not realized despite its advantages

I have chosen this website as this explains the topic with an historical perspective and at the same time explains the hardships in agreeing a free trade agreement.

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Comparative advantage is an economic law, dating back to the early 1800s, that demonstrates the ways in which protectionism (or mercantilism as it was called at the time) is unnecessary in free trade. Popularized by David Ricardo, comparative advantage argues that free trade works even if one partner in a deal holds absolute advantage in all areas of production - that is, one partner makes products cheaper, better and faster than its trading partner.

The primary fear for nations entering free trade is that they will be out-produced by a country with an absolute advantage in several areas, which would lead to imports but no exports. Comparative advantage stipulates that countries should specialize in a certain class of products for export, but import the rest - even if the country holds an absolute advantage in all products.

The essence of this law can be illustrated with a simple example. Imagine that you are a skilled cabinetmaker as well as a gifted painter. It takes you a day to build a cabinet or a day to paint a picture. In the local economy, paintings sell for $400 and cabinets go for $350. Your neighbor also shares the same skill sets, but it takes him a day and a half to build a cabinet and three days to complete a painting. You have an absolute advantage over your neighbor in both areas, so you should try to outproduce him across the board, right? Wrong.

Here's why: If you flip between painting and cabinetmaking over a six-day work week, you would produce three paintings and three cabinets worth $2,250. If your neighbor embarked upon the same work schedule, he would produce one painting and two cabinets worth $1,100. There would be a total of four paintings and five cabinets produced: a total of nine production units. If, however, you were to choose to focus on painting, the area where you have the greatest comparative advantage and the most profit, and leave cabinetmaking to your neighbor, something magical would happen. You would produce six paintings worth $2,400 per week, while your neighbor would produce four cabinets worth $1,400, bringing the total to 10 production units. In real terms, both you and your neighbor would be richer for specializing - and the local economy is one production unit the better for it.

Comparative Advantage and Free Trade

Economists have been uncommonly uniform in advocating free trade policies for centuries, and comparative advantage is the reason why. The theory suggests that total economic welfare in all countries is improved when countries focus on those industries where they have have the highest expertise and success, and the lowest opportunity costs.

To explain opportunity cost, we'll answer this question: Why don't NBA players mow their own lawns? Ostensibly, NBA players are stronger and faster than their landscapers and could do it more effectively. However, NBA players can maximize their value and productivity by focusing on basketball rather than wasting energy with a lawnmower; the opportunity cost is too high. Instead, the basketball player and landscaper each specialize and trade, using money as an intermediary representation of their respective productivity.

Comparative advantage says that countries should behave similarly. Laborers in the United States have relatively high levels of education and relatively advanced capital goods; this makes them very productive. However, that doesn't necessarily mean that American workers should produce everything that American consumers need. Instead, maximum efficiency and output can be achieved by specializing in those areas with the lowest opportunity costs and trading with other countries.

Free Trade Policies

Free-trade policies, in their truest form, advocate for a complete absence of import restrictions (such as tariffs and quotas) and for no subsidization of export industries. The proponents of free trade argue that restrictions on trade make all consumers, even Americans, poorer than they otherwise would have been.

The crux of the argument centers on the benefits of comparative advantage. When the laborers of one country specialize where they have the lowest opportunity costs, those industries achieve economies of scale and innovate. The increase in production causes prices to decline. American consumers see their real costs of living decline when cheap foreign goods are combined with cheaper domestic goods. Standards of living improve as a result.

Abbreviated as this explanation is, it highlights the academic arguments in favor of open international markets. During the 19 th century Industrial Revolution, for example, Britain provided support for comparative advantage by essentially outsourcing its food growth (importing grains, meat, cheese, wine, etc.) and focusing on manufacturing goods for export, thus becoming the workshop of the world for decades. And in today's increasingly international economy, the theory is even more relevant (see How does globalization impact comparative advantage?).

Why Isn't There Complete Free Trade?

If economists - who rarely agree - are almost uniformly in favor of free trade, why doesn't the world have open trading between countries? There are many reasons, but the most influential is something that economists call rent-seeking. Rent-seeking occurs when one group organizes and lobbies the government to protect its interests.

Say, for example, the producers of American shoes understand and agree with the free-trade argument - but they also know that their narrow interests would be negatively impacted by cheaper foreign shoes. Even if laborers would be most productive by switching from making shoes to making computers, nobody in the shoe industry wants to lose his or her job or see profits decrease in the short run. This desire leads the shoemakers to lobby for, say, special tax breaks for their products and/or extra duties (or even outright bans) on foreign footwear. Appeals to save American jobs and preserve a time-honored American craft abound - even though, in the long run, American laborers would be made relatively less productive and American consumers relatively poorer by such protectionist tactics.

The Bottom Line

Comparative advantage urges nations to engage in true free trade and to specialize in areas where they have the highest expertise and most success - instead of looking to bolster weak industries from foreign competition by imposing protective tariffs that otherwise stifle the production that leads to overall gains in wealth. The benefits of comparative advantage are reduced when domestic industries are subsidized or when foreign industries are subjected to import tariffs.

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Comparative advantage is an economic law, dating back to the early 1800s, that demonstrates the ways in which protectionism (or mercantilism as it was called at the time) is unnecessary in free trade.

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This website explains new and emerging trends in comparative advantage in services due to technology. It states that previously only goods were able to be exported, whereas services were not exported. This is due to the inability to export service. but in recent years due to advancements in information technology, services such as call centers, banking and entertainment are exported from other countries such as India. this website states that protectionism is only a temporary fix, preferred by politicians, but in the long run International competition, I will improve a Nation's competitiveness.

I have chosen this website as this is the only website that talked about the service sector as an export.

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Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. Opportunity cost measures a trade-off. A nation with a comparative advantage makes the trade-off worth it. The benefits of buying their good or service outweigh the disadvantages. The country may not be the best at producing something. But the good or service has a low opportunity cost for other countries to import.

For example, oil-producing nations have a comparative advantage in chemicals. Their locally-produced oil provides a cheap source of material for the chemicals when compared to countries without it. A lot of the raw ingredients are produced in the oil distillery process. As a result, Saudi Arabia, Kuwait, and Mexico are competitive with U.S. chemical production firms. Their chemicals are inexpensive, making their opportunity cost low.

Another example is India's call centers. U.S. companies buy this service because it is cheaper than locating the call center in America. Indian call centers aren't better than U.S. call centers. Their workers don't always speak English very clearly. But they provide the service cheaply enough to make the tradeoff worth it.

In the past, comparative advantages occurred more in goods and rarely in services. That's because products are easier to export. But telecommunication technology like the internet is making services easier to export. Those services include call centers, banking, and entertainment.

Theory of Comparative Advantage

Eighteenth-century economist David Ricardo created the theory of comparative advantage. He argued that a country boosts its economic growth the most by focusing on the industry in which it has the most substantial comparative advantage.

For example, England was able to manufacture cheap cloth. Portugal had the right conditions to make cheap wine. Ricardo predicted that England would stop making wine and Portugal stop making cloth. He was right. England made more money by trading its cloth for Portugal's wine, and vice versa. It would have cost England a lot to make all the wine it needed because it lacked the climate. Portugal didn't have the manufacturing ability to make cheap cloth. Therefore, they both benefited by trading what they produced the most efficiently.

This theory of comparative advantage became the rationale for free trade agreements. Ricardo developed his approach to combat trade restrictions on imported wheat in England. He argued that it made no sense to restrict low-cost and high-quality wheat from countries with the right climate and soil conditions. England would receive more value by exporting products that required skilled labor and machinery. It could acquire more wheat in trade than it could grow on its own.

The theory of comparative advantage explains why trade protectionism doesn't work in the long run. Political leaders are always under pressure from their local constituents to protect jobs from international competition by raising tariffs. But that's only a temporary fix. In the long run, it hurts the nation's competitiveness. It allows the country to waste resources on unsuccessful industries. It also forces consumers to pay higher prices to buy domestic goods.

David Ricardo started out as a successful stockbroker, making $100 million in today's dollars. After reading Adam Smith's " The Wealth of Nations," he became an economist. He was the first person to point out that significant increases in the money supply create inflation. This theory is known as monetarism.

He also developed the law of diminishing marginal returns. That's one of the essential concepts in microeconomics. It states that there is a point in production where the increased output is no longer worth the additional input in raw materials.

Example

One of America's comparative advantages is its vast land mass bordered by two oceans. It also has lots of fresh water, arable land, and available oil. U.S. businesses benefit from cheap natural resources and protection from land invasion.

Diversity also helped the United States became a global leader in banking, aerospace, defense equipment, and technology. Silicon Valley harnessed the power of diversity to become a leader in innovative thinking. Those combined advantages created the power of the U.S. economy.

Comparative Advantage Versus Absolute Advantage

Absolute advantage is anything a country does more efficiently than other countries. Nations that are blessed with an abundance of farmland, fresh water, and oil reserves have an absolute advantage in agriculture, gasoline, and petrochemicals.

Just because a country has an absolute advantage in an industry doesn't mean that it will be its comparative advantage. That depends on what the trading opportunity costs are. Say its neighbor has no oil but lots of farmland and fresh water. The neighbor is willing to trade a lot of food in exchange for oil. Now the first country has a comparative advantage in oil. It can get more food from its neighbor by trading it for oil than it could produce on its own.

Comparative Advantage Versus Competitive Advantage

Competitive advantage is what a country, business, or individual does that provide a better value to consumers than its competitors. There are three strategies companies use to gain a competitive advantage. First, they could be the low-cost provider. Second, they could offer a better product or service. Third, they could focus on one type of customer.

How It Affects You

Comparative advantage is what you do best while also giving up the least. For example, if you're a great plumber and a great babysitter, your comparative advantage is plumbing. That's because you'll make more money as a plumber. You can hire an hour of babysitting services for less than you would make doing an hour of plumbing. Your opportunity cost of babysitting is high. Every hour you spend babysitting is an hour's worth of lost revenue you could have gotten on a plumbing job.

Absolute advantage is anything you do more efficiently than anyone else. You're better than everyone else in the neighborhood at both plumbing and babysitting. But plumbing is your comparative advantage. That's because you only give up low-cost babysitting jobs to pursue your well-paid plumbing career.

Competitive advantage is what makes you more attractive to consumers than your competitors. For example, you are in demand to provide both plumbing and babysitting services. But it's not necessarily because you do them better (absolute advantage). It's because you charge less.

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What Really Makes One Country Better Than Another?

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Comparative advantage is when a country produces a good or service for a lower opportunity cost than other countries. Opportunity cost measures a trade-off. A nation with a comparative advantage makes the trade-off worth it. The benefits of buying their good or service outweigh the disadvantages.

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Research on this topic taught me very important lessons and the reasons for international trade. The most shocking aspect was to know that Canada exports nearly 30% of its GDP.

These days politicians like Donald Trump are weaponizing trade and hiking tariffs. This is not sustainable and counterproductive to the overall economy. Apart from these videos, I have researched many more topics. overall helped me to gain some insight into economics. This assignment my perspective on trade.

I may not explain all this information to my peers, but I can choose my leader wisely while I vote.