Assume that you were a small country what would you rather h

Assume that you were a small country, what would you rather have a comparative or absolute advantage with trading? Explain your reasoning.

Solution

Answer:

Gains from trade depend on the comparative advantage concept not on absolute advantage concept. So if a country has absolute advantages in both the goods, then it does not mean that it has comparative advantages in both of the goods.

If a country is good at producing both goods that means if it enjoys less time in producing more goods than another country then, we call that it enjoys absolute advantage in both the goods. Comparative advantage is relative concept. If a country has lowest opportunity cost in producing one good then we can say that country enjoys comparative advantage in producing that good. Opportunity cost is what could have been produced if this good has not been produced. So the forgone production is explained by the opportunity cost. So if a country will forgo less amount of production for a particular production of a good then, we can say that this particular production is beneficial for that country and it can produce that good and can trade with other countries. This can be explained by a simple example:

Two countries Australia and U.S.A. are producing two goods like bread and wheat and the quantity of goods they produce in an hour are given below:

                                          Bread               Wheat

                     Australia         20units          5units

                         U.S.A.        40units          20 units

So from the above example we can say that U.S.A. has absolute advantages in both of the goods that mean Wheat and Bread. Opportunity cost of a good is the cost that can be forgone to produce that good that means it measures that what could have been produced if that good would not been produced.

So the opportunity costs of unit production of:   

                                           Bread         Wheat

                        Australia          1/4            4

                          U.S.A.           1/2           2

So, U.S.A. has absolute advantage in both of the goods but has more opportunity cost in producing bread (1/2>1/4). So Australia has comparative advantage in producing bread as it has less opportunity cost in that production. So, it will produce bread and export bread to U.S.A. Again U.S.A. has less opportunity cost in producing wheat so, it is advantageous for U.S.A to produce wheat and export to Australia.

So it does not matter whether a country is small or big it always enjoys opportunity cost in producing something as it is a relative concept.