APMacro: Comparative Advantage and Specialization


The concept of comparative advantage is where one could specialize and trade as long as they could produce at a lower relative cost in terms of the other goods they could produce. Individuals and nations gain by producing goods at relatively low costs and exchanging their outputs for different goods produced by others at relatively low cost. All potential trading partners can gain enormously through appropriate specialization and exchange.

Calculating comparartive advantage

Comparative advantage illustrates how two nations can trade even if one is more efficient at producing both products. The country that is more efficient in the production of a good is the country that can produce the good with the least input. In other words, if the United States can produce a ton of oats in three hours and Scotland can produce a ton of oats in four hours, the United States is more efficient in the production of oats. In the language of economics, the United States would have an absolute advantage in the production of oats.

A nation has a comparative advantage in the good in which it has the lower opportunity cost. The nation should specialize in the good for which it has the lower opportunity cost and trade for the good for which the other country has the lower opportunity cost. A nation with an absolute advantage in the production of both goods will have a comparative advantage in the production of only one of these goods.

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Terms of trade is the exchange rate between two commodities, for example, two bananas for 30 grapes. The gains from trade are the additional amount of commodities a country has after specialization and trade in comparison with the combination before specialization and trade. For example, a country may gain five bananas relative to the total amount of bananas it had when producing only with its own resources.

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