Why
Nations
Trade
Chapter 18
1
Discussion Topics
Why trade?
Absolute advantage
Gains from trade
2
Concepts Affecting Trade
Absolute advantage – exists when one nation
can produce goods more cheaply than another
nation
Comparative advantage – ability of a nation to
specialize in the production of the good for
which it has lowest opportunity cost
Competitive advantage – economic
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competitiveness of a nation reflected in the
absolute cost of a given good in a given market
at a particular point in time
Pages 359-363
Comparative Advantage
Comparative advantage :
If one nation is less
efficient in the production of a good than another
nation, there is still a basis of gains from trade
 A nation should specialize in production and export
the good for which its relative (comparative)
advantage is greatest
 A nation should specialize in production and export the good
for which it has the least relative disadvantage
 A nation should import the good for which its relative
(comparative) advantage is the least
 A nation should import the good for which it has the greatest
relative disadvantage
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Pages 359-363
Ratio
5.00
0.67
U.S. is most efficient producer of wheat while
Mexico is most efficient producer of coffee
With trade
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 U.S.
 specializes in wheat
 exchange part of its surplus for coffee
 Mexico
 specialize in coffee
 trade part of the surplus for wheat
Page 360
Ratio
5.00
1.33
Mexico→ absolute disadvantage in producing both
goods
U.S.→ relative advantage greatest in wheat (10/2 vs.
4/3)
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 → U.S. has a comparative advantage in wheat
 →Mexico has the least comparative disadvantage in coffee
or comparative advantage in coffee
Page 361
Factors Affecting Comparative
Advantage….
National differences in opportunity costs
Costs affected by availability of resources
Costs affected by production
requirements for goods and services
produced
Costs affected by resource combinations
Costs affected by resource mobility
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Page 362
 We assume both countries fully employ all
resources, technology and specific amounts of
labor per year
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Page 364
U.S./Mexico Production Possibilities
U.S produces 100 tons of
wheat and 40 tons of coffee.
200
Mexico produces 32 tons of
wheat and 12 tons of coffee
U.S. (tons/year)
175
150
125
40
Mexico (tons/year)
32
24
100
16
75
50
25
0
9
8
20
40
60
80
0
12
24
36
48
60
Page 365
U.S./Mexico Production Possibilities
B
U.S. (tons/year)
175
150
125
C
100
Mexico (tons/year)
32
A
75
50
25
0
40
Wheat
Wheat
200
24
16
8
20
40
60
80
0
Coffee
Through trade
12
24
36
48
60
Coffee
U.S. specializes in wheat (pt B)
Trades 50 tons of wheat to Mexico for 45 tons of coffee
Consumes more of both goods at pt C (45 tons of coffee and
150 tons of wheat) than at pt A.
Comparing C w/ A → U.S. better of with trade
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Page 365
U.S. (tons/year)
B
175
150
125
C
100
A*
32
A
75
50
25
0
Mexico (tons/year)
40
Wheat
Wheat
200
C*
50
24
16
8
B*
20
40
Coffee
Through trade
60
80
0
12
24
36
48
60
Coffee
 Mexico specializes in coffee, 60 tons, pt. B* and no wheat
 Would trade 45 tons of coffee for 50 tons of wheat
 Consume more of both goods (50 tons of wheat and 15 tons
of coffee, pt C*) than at pt A*
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 Comparing C* w/ A* → Mexico better off with trade
Summary
 The law of comparative advantage was contrasted with
absolute advantage and competitive advantage.
 Trade occurs because traders anticipate gains from
trading.
 Comparative advantage determines why nations trade.
 The basis for trade is differing opportunity costs among
nations.
 Nations specialize in producing those goods in which
they are most efficient and exchange these goods with
other nations.
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