Define absolute benefit, comparative advantage, and opportunity costsExplain the gains of trade produced when a nation specializes

The Amerideserve to statesman Benjamin Franklin (1706–1790) when wrote: “No nation was ever before ruined by trade.” Many economists would certainly expush their perspectives toward worldwide profession in an even even more positive manner. The evidence that global trade confers as a whole benefits on economic situations is pretty strong. Trade has accompanied economic development in the United States and also around the civilization. Many kind of of the nationwide economies that have actually shown the many fast development in the last few decades—for example, Japan, South Korea, China, and also India—have done so by dramatically orienting their economies towards worldwide trade. Tbelow is no contemporary example of a country that has shut itself off from civilization profession and yet prospered. To understand also the benefits of profession, or why we profession in the initially location, we should understand the principles of comparative and also absolute benefit.

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In 1817, David Ricardo, a businessguy, economist, and also member of the British Parliament, created a treatise referred to as On the Principles of Political Economy and Taxation. In this writing, Ricarexecute said that field of expertise and also cost-free trade advantage all trading partners, also those that may be relatively inreliable. To watch what he supposed, we have to have the ability to differentiate between absolute and comparative benefit.

A country has an absolute advantage in producing a great over an additional country if it provides fewer resources to produce that great. Absolute benefit deserve to be the result of a country’s herbal endowment. For example, extracting oil in Saudi Arabia is pretty much simply a issue of “drilling a hole.” Producing oil in various other nations have the right to need substantial exploration and costly technologies for drilling and extraction—if indeed they have any type of oil at all. The USA has actually some of the wealthiest farmland in the world, making it much easier to thrive corn and wwarm than in many kind of other countries. Guatemala and Colombia have actually climates especially suited for growing coffee. Chile and Zambia have some of the world’s richest copper mines. As some have suggested, “geography is destiny.” Chile will carry out copper and also Guatemala will certainly develop coffee, and they will trade. When each nation has a product others require and also it deserve to be created via fewer resources in one country over an additional, then it is straightforward to imagine all parties benefitting from trade. However, thinking about trade simply in regards to location and also absolute benefit is incomplete. Trade really occurs because of comparative benefit.

Respeak to from the chapter Choice in a World of Scarcity that a nation has a comparative advantage once a good can be produced at a lower expense in terms of various other items. The question each country or company need to be asking as soon as it trades is this: “What carry out we provide approximately develop this good?” It have to be no surpincrease that the concept of comparative advantage is based on this idea of possibility cost from Choice in a World of Scarcity. For example, if Zambia concentrates its sources on creating copper, its labor, land and financial resources cannot be offered to develop various other items such as corn. As a result, Zambia offers up the possibility to develop corn. How carry out we quantify the expense in terms of other goods? Simplify the problem and also assume that Zambia simply needs labor to create copper and corn. The suppliers that develop either copper or corn tell you that it takes 10 hours to mine a ton of copper and 20 hours to harvest a bushel of corn. This indicates the opportunity price of producing a ton of copper is 2 bushels of corn. The next area establishes absolute and comparative advantage in greater information and relates them to trade.


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A Numerical Example of Absolute and also Comparative Advantage

Consider a theoretical human being via 2 countries, Saudi Arabia and also the USA, and also two commodities, oil and also corn. Additional assume that consumers in both countries desire both these products. These items are homogeneous, interpretation that consumers/producers cannot identify in between corn or oil from either nation. Tright here is just one reresource accessible in both countries, labor hours. Saudi Arabia have the right to create oil via fewer sources, while the USA can develop corn with fewer resources. Table 1 illustrates the benefits of the two nations, expressed in terms of how many type of hrs it takes to create one unit of each excellent.

CountryOil (hrs per barrel)Corn (hrs per bushel)
Saudi Arabia14
United States21
Table 1. How Many type of Hours It Takes to Produce Oil and also Corn

In Table 1, Saudi Arabia has an absolute benefit in the manufacturing of oil because it just takes an hour to develop a barrel of oil compared to 2 hours in the United States. The USA has an absolute benefit in the manufacturing of corn.

To simplify, let’s say that Saudi Arabia and the USA each have 100 worker hrs (watch Table 2). We illustrate what each nation is qualified of creating on its very own making use of a production possibility frontier (PPF) graph, displayed in Figure 1. Recontact from Choice in a World of Scarcity that the manufacturing possibilities frontier reflects the maximum amount that each nation have the right to produce offered its restricted sources, in this instance workers, and also its level of technology.

CountryOil Production making use of 100 worker hrs (barrels)Corn Production making use of 100 worker hrs (bushels)
Saudi Arabia100or25
United States50or100
Table 2. Production Possibilities before Trade

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Figure 1. Production Possibilities Frontiers. (a) Saudi Arabia deserve to produce 100 barrels of oil at maximum and zero corn (point A), or 25 bushels of corn and also zero oil (suggest B). It can also create other combicountries of oil and corn if it wants to consume both items, such as at allude C. Here it chooses to produce/consume 60 barrels of oil, leaving 40 job-related hours that deserve to be allocated to creating 10 bushels of corn, using the data in Table 1. (b) If the United States produces just oil, it have the right to create, at maximum, 50 barrels and also zero corn (allude A’), or at the various other excessive, it have the right to produce a maximum of 100 bushels of corn and also no oil (point B’). Other combinations of both oil and corn are feasible, such as suggest C’. All points over the frontiers are difficult to develop offered the present level of sources and innovation.

Arguably Saudi and U.S. consumers desire both oil and also corn to live. Let’s say that before profession occurs, both nations develop and also consume at allude C or C’. Thus, prior to trade, the Saudi Arabian economy will certainly devote 60 worker hrs to create oil, as shown in Table 3. Given the information in Table 1, this option indicates that it produces/consumes 60 barrels of oil. With the staying 40 worker hours, because it demands 4 hours to produce a bushel of corn, it deserve to develop just 10 bushels. To be at suggest C’, the U.S. economic climate devotes 40 worker hrs to create 20 barrels of oil and the continuing to be worker hours deserve to be allocated to create 60 bushels of corn.

CountryOil Production (barrels)Corn Production (bushels)
Saudi Arabia (C)6010
United States (C’)2060
Total World Production8070
Table 3. Production prior to Trade

The slope of the production opportunity frontier illustprices the possibility cost of developing oil in terms of corn. Using all its sources, the USA deserve to develop 50 barrels of oil or 100 bushels of corn. So the chance expense of one barrel of oil is 2 bushels of corn—or the slope is 1/2. Hence, in the U.S. production possibility frontier graph, eexceptionally increase in oil production of one barrel implies a decrease of two bushels of corn. Saudi Arabia deserve to create 100 barrels of oil or 25 bushels of corn. The possibility expense of developing one barrel of oil is the loss of 1/4 of a bushel of corn that Saudi workers could otherwise have created. In terms of corn, notification that Saudi Arabia gives up the leastern to create a barrel of oil. These calculations are summarized in Table 4.

CountryOpportunity expense of one unit — Oil (in terms of corn)Opportunity cost of one unit — Corn (in terms of oil)
Saudi Arabia¼4
United States2½
Table 4. Opportunity Cost and Comparative Advantage

Again recall that comparative advantage was identified as the opportunity price of creating items. Due to the fact that Saudi Arabia offers up the least to develop a barrel of oil, (1414 Table 4) it has actually a comparative advantage in oil manufacturing. The United States gives up the leastern to create a bushel of corn, so it has actually a comparative advantage in corn manufacturing.

In this example, there is symmeattempt in between absolute and comparative advantage. Saudi Arabia needs fewer worker hours to produce oil (absolute advantage, see Table 1), and additionally gives up the leastern in regards to other products to create oil (comparative benefit, see Table 4). Such symmetry is not always the case, as we will present after we have actually disputed gains from trade completely. But initially, read the adhering to Clear It Up attribute to make certain you understand why the PPF line in the graphs is straight.


Can a production possibility frontier be straight?

When you initially met the production possibility frontier (PPF) in the chapter on Choice in a World of Scarcity it was attracted via an outward-bfinishing form. This shape depicted that as inputs were moved from creating one good to another—prefer from education and learning to health services—tright here were enhancing opportunity costs. In the examples in this chapter, the PPFs are attracted as directly lines, which indicates that chance expenses are continuous. When a marginal unit of labor is transferred away from prospering corn and also toward creating oil, the decrease in the amount of corn and also the increase in the amount of oil is constantly the very same. In reality this is feasible just if the contribution of extra workers to output did not adjust as the range of manufacturing changed. The linear production possibilities frontier is a much less realistic design, yet a right line simplifies calculations. It also illustrates financial themes prefer absolute and comparative benefit just as plainly.


Gains from Trade

Consider the trading positions of the United States and Saudi Arabia after they have specialized and also traded. Before trade, Saudi Arabia produces/consumes 60 barrels of oil and also 10 bushels of corn. The United States produces/consumes 20 barrels of oil and also 60 bushels of corn. Given their current manufacturing levels, if the USA have the right to trade an amount of corn fewer than 60 bushels and also receives in exadjust an amount of oil higher than 20 barrels, it will get from trade. With trade, the USA can consume even more of both goods than it did without specialization and trade. (Respeak to that the chapter Welcome to Economics! defined expertise as it applies to employees and firms. Specialization is additionally used to define the occurrence once a country shifts resources to emphasis on developing a great that supplies comparative advantage.) Similarly, if Saudi Arabia can profession an amount of oil less than 60 barrels and get in exadjust an amount of corn greater than 10 bushels, it will have actually even more of both products than it did before field of expertise and trade. Table 5 illustprices the range of trades that would advantage both sides.

The U.S. Economy, after Specialization, Will Benefit If It:The Saudi Arabian Economy, after Specialization, Will Benefit If It:
Exports no even more than 60 bushels of cornImports at least 10 bushels of corn
Imports at least 20 barrels of oilExports much less than 60 barrels of oil
Table 5. The Range of Trades That Benefit Both the United States and Saudi Arabia

The underlying reason why profession benefits both sides is rooted in the concept of chance expense, as the adhering to Clear It Up function describes. If Saudi Arabia wishes to expand also domestic manufacturing of corn in a world without worldwide profession, then based on its chance expenses it must offer up 4 barrels of oil for every one additional bushel of corn. If Saudi Arabia could uncover a method to offer up less than four barrels of oil for a second bushel of corn (or equivalently, to get more than one bushel of corn for 4 barrels of oil), it would be better off.


What are the possibility costs and gains from trade?

The selection of trades that will advantage each nation is based on the country’s possibility cost of producing each great. The United States have the right to produce 100 bushels of corn or 50 barrels of oil. For the United States, the opportunity expense of producing one barrel of oil is 2 bushels of corn. If we divide the numbers over by 50, we acquire the exact same ratio: one barrel of oil is equivalent to 2 bushels of corn, or (100/50 = 2 and also 50/50 = 1). In a profession with Saudi Arabia, if the USA is going to offer up 100 bushels of corn in exports, it should import at least 50 barrels of oil to be simply also off. Clearly, to get from profession it requirements to be able to obtain even more than a half barrel of oil for its bushel of corn—or why trade at all?


Recall that David Ricarexecute argued that if each nation specializes in its comparative advantage, it will benefit from trade, and also complete worldwide output will rise. How can we present gains from profession as an outcome of comparative benefit and also specialization? Table 6 reflects the output assuming that each nation specializes in its comparative advantage and also produces no other excellent. This is 100% specialization. Specialization leads to a rise in complete people production. (Compare the total people manufacturing in Table 3 to that in Table 6.)

CountryQuantity developed after 100% specialization — Oil (barrels)Quantity created after 100% specialization — Corn (bushels)
Saudi Arabia100 0
United States 0100
Total World Production100100
Table 6. How Specialization Expands Output

What if we did not have actually finish specialization, as in Table 6? Would there still be gains from trade? Consider another instance, such as when the USA and also Saudi Arabia start at C and C’, respectively, as presented in Figure 1. Consider what occurs once trade is allowed and also the USA exports 20 bushels of corn to Saudi Arabia in exadjust for 20 barrels of oil.


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Figure 2. Production Possibilities Frontier in Saudi Arabia. Gains from trade of oil ca rise just by achieving less from trade of corn. The oppowebsite is true as well: The more gains from profession of corn, the fewer gains from profession of oil.

Starting at suggest C, alleviate Saudi Oil production by 20 and exchange it for 20 devices of corn to reach suggest D (check out Figure 2). Notice that also without 100% field of expertise, if the “trading price,” in this case 20 barrels of oil for 20 bushels of corn, is higher than the country’s chance expense, the Saudis will acquire from profession. Certainly both countries consume even more of both items after specialized production and also profession occurs.


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Key Concepts and Summary

A nation has an absolute benefit in those commodities in which it has actually a productivity edge over various other countries; it takes fewer resources to create a product. A country has actually a comparative advantage as soon as an excellent have the right to be produced at a lower cost in terms of other goods. Countries that specialize based upon comparative benefit acquire from profession.


Self-Check Questions

True or False: The source of comparative benefit need to be herbal elements like climate and mineral deposits. Explain.Brazil have the right to produce 100 pounds of beef or 10 autos; in comparison the United States deserve to develop 40 pounds of beef or 30 autos. Which nation has the absolute benefit in beef? Which nation has actually the absolute benefit in developing autos? What is the opportunity price of producing one pound of beef in Brazil? What is the opportunity cost of producing one pound of beef in the United States?In France it takes one worker to produce one sweater, and one worker to develop one bottle of wine. In Tunisia it takes two employees to produce one sweater, and also 3 workers to produce one bottle of wine. Who has the absolute benefit in manufacturing of sweaters? Who has actually the absolute advantage in the production of wine? How can you tell?

Recheck out Questions

What is absolute advantage? What is comparative advantage?Under what conditions does comparative benefit result in gains from trade?What components does Paul Krugguy identify that supported the growth of global trade in the 1800s?

Critical Thinking Questions

Are distinctions in geography behind the distinctions in absolute advantages?Why does the USA not have actually an absolute advantage in coffee?

Problems

France and also Tunisia both have actually Mediterranean climates that are terrific for producing/harvesting green beans and also tomatoes. In France it takes 2 hours for each worker to harvest green beans and also 2 hrs to harvest a tomato. Tunisian workers require just one hour to harvest the tomatoes yet four hrs to harvest green beans. Assume there are just two employees, one in each country, and also each works 40 hours a week.

Draw a production possibilities frontier for each country. Hint: Remember the manufacturing possibility frontier is the maximum that all workers deserve to develop at a unit of time which, in this trouble, is a week.Identify which country has actually the absolute benefit in green beans and also which nation has actually the absolute advantage in tomatoes.Identify which nation has actually the comparative benefit.How a lot would France need to provide up in terms of tomatoes to get from trade? How much would it need to offer up in regards to green beans?

References

Krugmale, Paul R. Pop Internationalism. The MIT Press, Cambridge. 1996.

Krugguy, Paul R. “What Do Undergrads Need to Know about Trade?” Amerihave the right to Economic Review 83, no. 2. 1993. 23-26.

Ricarperform, David. On the Principles of Political Economy and also Taxation. London: John Murray, 1817.

Ricardo, David. “On the Principles of Political Economy and Taxation.” Library of Economics and Liberty. http://www.econlib.org/library/Ricardo/ricP.html.


Glossary

absolute advantagewhen one nation have the right to usage fewer sources to create a good compared to an additional country; once a country is more abundant compared to another countryobtain from tradea country that deserve to consume more than it have the right to produce as an outcome of expertise and trade

Solutions

Answers to Self-Check Questions

False. Anything that leads to different levels of efficiency between two economies deserve to be a source of comparative advantage. For example, the education of workers, the understanding base of engineers and scientists in a nation, the part of a split-up value chain wbelow they have actually their specialized finding out, economic climates of scale, and also other factors have the right to all determine comparative advantage.Brazil has the absolute benefit in developing beef and the United States has the absolute benefit in autos. The possibility price of producing one pound of beef is 1/10 of an auto; in the United States it is 3/4 of an auto.In answering concerns prefer these, it is often helpful to begin by organizing the indevelopment in a table, such as in the complying with table. Notice that, in this situation, the productivity of the countries is expressed in terms of exactly how many type of workers it takes to produce a unit of a product.CountryOne SweaterOne Bottle of wine
France1 worker1 worker
Tunisia2 workers3 workers
Table 7.

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In this example, France has actually an absolute advantage in the manufacturing of both sweaters and wine. You can tell bereason it takes France much less labor to develop a unit of the great.