International Trade: Absolute and Comparative Advantage
Absolute advantage exists when one country can produce more of a good than another country using the same quantity of resources, i.e. it is more productive.
Before you start
No specific prerequisites - this is a good place to start.
Method
- Set up a production possibility table for two countries and two goods, showing the output each country can produce with a given amount of resource (e.g. one worker-day).
- Calculate the opportunity cost of producing each good in each country: the amount of the other good given up per unit produced.
- Identify which country has the comparative advantage in each good, i.e. the lower opportunity cost of producing it.
- State the trading rule: each country should specialise fully or partly in, and export, the good in which it has the comparative advantage.
- Show the gains from trade by comparing total combined output before specialisation with total combined output after specialisation (or, for a numerical terms-of-trade question, identify the range of exchange rates within which both countries gain).
- List the assumptions underlying the theory: no transport costs, no trade barriers, constant returns to scale, homogeneous goods, perfect information, and factors of production that are mobile domestically but immobile internationally.
- Evaluate against real-world frictions: transport costs and trade barriers reduce the size of the gains, factors of production are not always mobile within a country (workers in a declining industry may not easily retrain), and the theory does not on its own guarantee that gains from trade are shared evenly, either between countries or between winners and losers within a country.
Worked example
With one worker-day, Country A can produce either 10 units of cloth or 5 units of wine. With one worker-day, Country B can produce either 6 units of cloth or 2 units of wine. Calculate the opportunity cost of producing cloth and wine in each country, identify which country has the comparative advantage in each good, and state which good each country should specialise in.
- Calculate Country A's opportunity cost of cloth: 5 wine given up / 10 cloth produced = 0.5 wine per unit of cloth.
- Calculate Country B's opportunity cost of cloth: 2 wine given up / 6 cloth produced = 0.33 wine per unit of cloth (to two decimal places).
- Compare: Country B's opportunity cost of cloth (0.33) is lower than Country A's (0.5), so Country B has the comparative advantage in cloth.
- Calculate Country A's opportunity cost of wine: 10 cloth given up / 5 wine produced = 2 cloth per unit of wine.
- Calculate Country B's opportunity cost of wine: 6 cloth given up / 2 wine produced = 3 cloth per unit of wine.
- Compare: Country A's opportunity cost of wine (2) is lower than Country B's (3), so Country A has the comparative advantage in wine. Country A should specialise in wine and Country B should specialise in cloth, then trade.
Practice questions
Try each question, then tap to reveal the answer.
Q1Define absolute advantage.Show answer
Answer: The ability of a country to produce more of a good than another country using the same quantity of resources.
Q2Define comparative advantage.Show answer
Answer: The ability of a country to produce a good at a lower opportunity cost, in terms of other goods forgone, than another country.
Q3Can a country have an absolute advantage in producing a good but not a comparative advantage in it? Explain.Show answer
Answer: Yes. A country can be more productive in absolute terms at everything but still have a higher opportunity cost in a particular good than its trading partner, in which case it does not have the comparative advantage.
Q4With one hour of labour, Country X can produce 8 units of good A or 4 units of good B. Calculate the opportunity cost of producing one unit of good A in Country X.Show answer
Answer: 4 / 8 = 0.5 units of good B per unit of good A.
Q5Name one assumption of the theory of comparative advantage.Show answer
Answer: For example, no transport costs, no trade barriers, constant returns to scale, or perfectly mobile factors of production within a country.
Q6Give one reason why the theoretical gains from trade might not be fully realised in practice.Show answer
Answer: For example, transport costs, tariffs and other trade barriers, or workers in a declining industry being unable to retrain and move into the expanding export industry.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
With one worker-day, Country M can produce either 20 units of grain or 10 units of textiles. With one worker-day, Country N can produce either 8 units of grain or 8 units of textiles. Calculate the opportunity cost of producing textiles in each country and identify which country should specialise in textiles.
Show mark scheme
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Evaluate the extent to which the theory of comparative advantage justifies a policy of free trade between countries.
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See real A Level Economics past-paper questions, with official mark schemes →
Free printable worksheet
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