Global Economics – Trade Advantages

What is “Global Economics – Trade Advantage”?

There are two types of trade advantages – absolute advantage and comparative advantage. ‘Absolute trade advantage’ refers to the difference in productivity levels between countries, which is related to the cost of production. A country has an absolute advantage over other countries if its cost of producing good X or Y is lower than in other countries. ‘Comparative trade advantage’ is similar, however, it focuses on differences in opportunity costs of production between countries. A country has a comparative trade advantage only if its opportunity cost of producing a product is less than other countries.

The advantage of international trade is that it enhances the economic growth of all countries, as it increases the efficiency of resources and how they are allocated, and this provides for a larger capital pool and markets for specific products.

Comparative Trade Advantage

While absolute advantage always refers to the low-cost producer, with the comparative advantage that is not necessarily the case. In fact, it’s quite possible for a country to have a comparative advantage in producing a product while not having an absolute advantage in producing the same.

For example, take two countries, Country A and Country B, each producing two products – X and Y. Now assume that Country A has an absolute advantage in producing both products i.e. its cost of production vis-à-vis both products is lower than that of Country B.

However, if we look at opportunity costs, assume that Country A has a comparative advantage in producing product X, while Country B has a comparative advantage in producing product Y. We can determine this by calculating the relative costs of producing product Y versus producing product X and producing product X versus producing product Y.

Next, let’s look at the advantage of international trade for countries, in terms of efficiency of resources. In the first scenario, assume that there is no trade between countries, and Country A and Country B produce a certain quantity of both products – X and Y. Both countries produce 100 units of good X and 50 units of good Y each. Producing both these goods requires a level of resources valued at $1,000 and $1,300 for Country A and Country B respectively. Therefore, under a no-trade scenario the total amount of resources used to produce these two goods is $1,000 + $1,300 = $2,300.

In the second scenario, both countries trade and assume that Country A produces all of product X and Country B produces all of product Y. Then they trade, based upon their requirements and resources. Now, assume that the total amount of resources used is also $2,300 in this scenario (of trade). However, the key difference here, compared to when no trade was taking place is that here Country B is able to produce 54 units of good Y under a trade scenario, instead of 50 units under a no-trade scenario, and is able to trade the same for 100 units of good X from Country A. Therefore, both countries benefit through four additional units of product Y.

In global economics, countries tend to specialize in those goods and services in which they have a comparative advantage, and all countries participating in that trade can benefit similarly. The sources of comparative advantages generally come from labor productivity and the same is attributed to differences in technology. As nations develop technologies that create a comparative advantage in producing certain products, they shift their resources in that direction and then fill in their requirements for other products through trade.

Trade Advantages, Example

Given below is an example. We have two countries that trade with each other and both produce product A and product B. China has a lower cost of production vis-à-vis both products i.e. China has an absolute advantage In both products. However, looking at opportunity costs, China only has a comparative advantage in producing product A, while the US has a comparative advantage in producing product B.

In the no-trade scenario, the total level of resources used is $34,500.

In the second (trade takes place between both countries) scenario, the total level of resources used is $33,000. Therefore, the trade advantage is clearly evident.