Explain why countries can gain from trade even without havin

Explain why countries can gain from trade even without having an absolute advantage?

Solution

Answer:

Countries can gain from trade even without having an absolute advantage. The reason behind this gain is comparative advantage that is totally different concept. A country cannot has comparative advantages in both of the goods but can has absolute advantage in both the goods during trade with another country. If we say a country has comparative advantage in a good that means it enjoys lower opportunity cost in producing that good. Comparative advantage is a relative concept whereas absolute advantage is an absolute concept. So a country can produce many goods more than other countries but cannot have less opportunity costs in all goods. This can be explained by a simple example.

Two countries U.K. and U.S.A. are producing two goods like cloth and rice and the quantity of goods they produce in an hour are given below:

                                          Cloth               Rice

                         U.K.           10units          5units

                         U.S.A.        20units          20 units

So from the above example we can say that U.S.A. has absolute advantages in both of the goods that mean rice and cloth. The comparative advantage is a different concept and can be explained by opportunity cost concept. 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:   

                                           Cloth         Rice

                         U.K           1/2            2

                          U.S.A.      1               1

So, U.S.A. has absolute costs in both of the goods but has more opportunity cost in producing cloth (1/2<1). So U.K has comparative advantage in producing cloth as it has less opportunity cost in that production. So, it will produce cloth and export cloth to U.S.A. Again U.S.A. has less opportunity cost in producing rice so it is advantageous for U.S.A to produce rice and export rice to U.K. The trade price will be in between the opportunity costs like trade price of cloth will be in between 1 and 1/2. Otherwise trade will not be benificial for both the countries.

So it clear that trade will depend upon the comparative advantage concept rather than the absolute advantage concept.