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4. Specialization and trade

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When a country has a comparative advantage in the production of a good, it means that it can produce this good at a lower opportunity cost than its trading partner. Then the country will specialize in the production of this good and trade it for other goods.

The following graphs show the production possibilities frontiers (PPFs) for Candonia and Desonia. Both countries produce lemons and coffee, each initially (i.e., before specialization and trade) producing 24 million pounds of lemons and 12 million pounds of coffee, as indicated by the grey stars marked with the letter A.

Created with Raphaël 2.1.2Candonia08162432404856646456484032241680COFFEE (Millions of pounds)LEMONS (Millions of pounds)PPFA

Created with Raphaël 2.1.2

Created with Raphaël 2.1.2Desonia08162432404856646456484032241680COFFEE (Millions of pounds)LEMONS (Millions of pounds)PPFA

Created with Raphaël 2.1.2

Candonia has a comparative advantage in the production of selector 1

lemons

coffee

neither lemons nor coffee

both lemons and coffee

, while Desonia has a comparative advantage in the production of selector 2

lemons

coffee

neither lemons nor coffee

both lemons and coffee

. Suppose that Candonia and Desonia specialize in the production of the goods in which each has a comparative advantage. After specialization, the two countries can produce a total of

million pounds of lemons and

million pounds of coffee.

Points:

Close Explanation

Explanation:

Suppose that Candonia and Desonia agree to trade. Each country focuses its resources on producing only the good in which it has a comparative advantage. The countries decide to exchange 8 million pounds of lemons for 8 million pounds of coffee. This ratio of goods is known as the terms of trade between Candonia and Desonia.

The following graph shows the same PPF for Candonia as before, as well as its initial consumption at point A. Place a black point (plus symbol) on the graph to indicate Candonia\'s consumption after trade.

Note: Dashed drop lines will automatically extend to both axes.

Created with Raphaël 2.1.2CandoniaConsumption After Trade08162432404856646456484032241680COFFEE (Millions of pounds)LEMONS (Millions of pounds)PPFA

Created with Raphaël 2.1.2

Points:

Close Explanation

Explanation:

The following graph shows the same PPF for Desonia as before, as well as its initial consumption at point A.

As you did for Candonia, place a black point (plus symbol) on the following graph to indicate Desonia\'s consumption after trade.

Created with Raphaël 2.1.2DesoniaConsumption After Trade08162432404856646456484032241680COFFEE (Millions of pounds)LEMONS (Millions of pounds)PPFA

Created with Raphaël 2.1.2

Points:

Close Explanation

Explanation:

True or False: Without engaging in international trade, Candonia and Desonia would not have been able to consume at the after-trade consumption bundles. (Hint: Base this question on the answers you previously entered on this page.)

True

False

Solution

Not Able to understand the questions.

If you do everything better than anyone else, should you be self-sufficient and do everything yourself? Self-sufficiency is one possibility, but it turns out you can do better and make others better off in the process. By instead concentrating on the things you do the \"most best\" and exchanging or trading any excess of those things with someone else for the things that person does the \"most best,\" you can both be better off. Comparative advantage fleshes out what is meant by \"most best\". It is one of the key principles of economics.

The theory of comparative advantage is an economic theory about the work gains from trade for individuals, firms, or nations that arise from differences in their factor endowments or technological progress. In an economic model, an agent has a comparative advantage over another in producing a particular good if he can produce that good at a lower relative opportunity cost or autarky price, i.e. at a lower relative marginal cost prior to trade.^[2] One does not compare the monetary costs of production or even the resource costs (labor needed per unit of output) of production. Instead, one must compare the opportunity costs of producing goods across countries.^[3] The closely related law or principle of comparative advantage holds that under free trade, an agent will produce more of and consume less of a good for which he has a comparative advantage.

Ricardo\'s example-

In a famous example, Ricardo considers a world economy consisting of two countries, Portugal and England, which produce two goods of identical quality. In Portugal, the a priori more efficient country, it is possible to produce wine and cloth with less labor than it would take to produce the same quantities in England. However, the relative costs of producing those two goods differ between the countries.

Hours of work necessary to produce one unit

Country

Cloth

Wine

England

100

120

Portugal

90

80

In this illustration, England could commit 100 hours of labor to produce one unit of cloth, or produce units of wine. Meanwhile, in comparison, Portugal could commit 90 hours of labor to produce one unit of cloth, or produce units of wine. So, Portugal possesses an absolute advantage in producing cloth due to fewer labor hours, and England has a comparative advantage due to lower opportunity cost.

In the absence of trade, England requires 220 hours of work to both produce and consume one unit each of cloth and wine while Portugal requires 170 hours of work to produce and consume the same quantities. England is more efficient at producing cloth than wine, and Portugal is more efficient at producing wine than cloth. So, if each country specializes in the good for which it has a comparative advantage, then the global production of both goods increases, for England can spend 220 labor hours to produce 2.2 units of cloth while Portugal can spend 170 hours to produce 2.125 units of wine. Moreover, if both countries specialize in the above manner and England trades a unit of its cloth for to units of Portugal\'s wine, then both countries can consume at least a unit each of cloth and wine, with 0 to 0.2 units of cloth and 0 to 0.125 units of wine remaining in each respective country to be consumed or exported. Consequently, both England and Portugal can consume more wine and cloth under free trade than in autarky

Hours of work necessary to produce one unit
Country	Cloth	Wine
England	100	120
Portugal	90	80