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"Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods." Explain. (includes detailed example)

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Topics: Economics
In the world market, countries trade products they wouldn't be able to produce on their own. Countries like Cuba specializes in cigar production, Japan in electronics, and Russia in rocket technology. However, even if a country has an absolute advantage in producing all goods, they still will benefit from trade. Many economic factors are involved with trade. Among the major factors are opportunity costs, comparative advantage, specialization and finally trade.

Opportunity cost is defined as the value of the best alternative forgone when an item or activity is chosen. In other words, opportunity cost is the cost of choice. For example: the opportunity cost of producing a car is the time that could've been used to produce something else, say paper. For a country (country A) that has an absolute advantage ( the ability to produce something using fewer resources than other producers use ) in producing both cars and paper, the opportunity cost of producing say, 1 car is the production of 3 tons of paper. Thus, what product a country chooses to specialize on must be chosen so as to produce as much as possible while suffering as little opportunity cost as possible.

Which goods the country should specialize on should be monitored by the law of comparative advantage, which states that: the country with the lowest opportunity cost of producing a particular good should specialize in producing that good. By specializing on a certain good, a country lowers the opportunity cost of that good by forgoing production of other goods. For example: Say country A has an absolute advantage in producing cars as well as paper, and the opportunity cost of producing 1 car is 3 tons of paper. Country B however, produces 1 car at an opportunity cost of 6 tons of paper. If these two countries specialized according to comparative advantage, country A produces 2 cars whilst country B produces 12 tons of paper. Therefore, country B should concentrate on solely producing paper and hand over the job of car production entirely to country A.

To gain the maximum benefits of specialization among countries, countries should trade their products with products from other countries. In the example above, the total output of cars and paper has increased as a result of specialization. But exactly how much should both countries trade to gain the highest possible benefits? By trading 1 car for 4 tons of paper, country A will gain 1 ton of paper while country B gains 2 tons of paper. Hence, both countries gain more paper by trade without increasing their resources.

Country A

Country B

Cars Paper (tons) Cars Paper (tons)

Without trade:

Production and consumption 1 3 1 6

With Trade:

Production 2 0 0 12

Trade Gives 1 Gets 4 Gets 1 Gives 4

Consumption 1 4 1 8

Gains from Trade:

Increase in Consumption None +1 ton None +2 tons

In conclusion, all the economic factors mentioned combined with trade allows benefits even to a country that has the ability to produce goods while using fewer resources than other countries.

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