Economics of Trade

Assess the ways in which economic factors influence international trade and operations.

I can determine whether a country has a competitive advantage

• There are many advantages to trading.• Jobs, markets, technology, variety of products, and

competition.• But, is international trade good for everybody?• What about underdeveloped and developing

countries?• Can they really gain from trading or are wealthy

countries and corporations just taking advantage of them?

• These questions can be answered theoretically using the economic concepts of absolute and comparative advantage.

Absolute Advantage• One country has an absolute advantage if it makes

a product or service more productively than other countries.

• The country uses its resources efficiently to manufacture more products or manufactures more products with the same amount of resources.

• The country with an absolute advantage has better technology or labour or higher quality resources.

Canada’s Absolute Advantage

Hypothetical example:• Let’s pretend there are only 2 countries in the

world: Canada and the USA• They can each produce apples and peaches• But if each country uses half its resources to

produce each, they produce different amounts.

Apples Peaches

Canada 1000 600

Unites States 800 1400

Total 1800 2000

It makes more sense for each country to specialize in products in which they have an absolute advantage.

Each country would make twice as much of the product in which it has an absolute advantage and none of the other product.

Apples Peaches

Canada 2000 0

United States 0 2800

Total 2000 2800

• Overall, more apples and peaches are produced.• Canada has an absolute advantage in apples and

the USA has an absolute advantage in peaches.• Canada and the United States will trade• Canada will trade apples for peaches and the

USA will trade peaches for apples

• What if one of the countries is more productive at manufacturing both products?

• Is it still beneficial to trade?

Apples Peaches

Canada 1000 500

United States 1200 800

Total 2200 1300

• In this case, should the countries still trade?• Yes they should.• To understand why, you need to understand the

concept of opportunity cost.• Opportunity cost is the value of what is foregone.• The cost of giving something up for something

else.• For example: you being in school instead of

working and making money.

Comparative Advantage

• Let’s look at how efficient each country is at producing peaches.

• In Canada, 1 peach costs 1000apples/500peaches = 2 apples

• In the USA, 1 peach costs 1200apples/800peaches = 1.5 apples

• The opportunity cost of peaches is lowest in the USA, therefore, the USA should produce peaches

•

Comparative Advantage cont’d

• Let’s look at how efficient each country is at producing apples.

• In Canada, 1 apple costs 500peaches/1000apples = .5 peaches

• In the USA, 1 apple costs 800peaches/1200apples = .667 peaches

• The opportunity cost of apples is lowest in the USA, therefore, Canada should produce apples.

Where’s the advantage?Apples Peaches

Canada 2000 0

United States 0 1600

2000 1600

• Trade is advantageous to both countries because 200 apples has been given up for 300 peaches.

• So when you leave it to a country to specialize in its’ own efficiency, then production goes up.

• Also, since Canada specializes in apples, it can make up the 200 units since it is more efficient than the USA in apple production.

• Comparative advantage is the foundation for specialization and trade.

• Both countries benefit if they take advantage of each others comparative advantage.

• World trade involves millions of products and many countries, however, the study of absolute and comparative advantage demonstrates that trade is beneficial to all.