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Chapter 33: Q.9 (page 803)

Under what conditions does comparative advantage lead to gains from trade?

Short Answer

Expert verified

When efforts are focused on product they specialize in and producing at a lower opportunity cost for other countries.

Step by step solution

01

Step 1. Introduction

Opportunity cost refers to the cost of sacrificing or giving up the second best alternative. Comparative advantage refers to the ability of a person, firm, or region to produce a product at a comparatively lower opportunity cost than others.

02

Step 2. Explanation

People or firms who possess a comparative advantage in any product can gain it through specialization. When all the efforts are focused on producing the good or service they have a comparative advantage in, they can gain achieve specialization. By trading the products they specialize in and depending on others for goods they do not specialize in, benefits can be obtained from trade.

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Most popular questions from this chapter

Does intra-industry trade contradict the theory of comparative advantage?

True or False: The source of comparative advantage must be natural elements like climate and mineral deposits. Explain

What is splitting up the value chain?

You just overheard your friend say the following: “Poor countries like Malawi have no absolute advantages. They have poor soil, low investments in formal education and hence low-skill workers, no capital, and no natural resources to speak of. Because they have no advantage, they cannot benefit from trade.” How would you respond?

Review the numbers for Canada and Venezuela from Table 19.12 which describes how many barrels of oil and tons of lumber the workers can produce. Use these numbers to answer the rest of this question.

a. Draw a production possibilities frontier for each country. Assume there are 100 workers in each country. Canadians and Venezuelans desire both oil and lumber. Canadians want at least 2,000 tons of lumber. Mark a point on their production possibilities where they can get at least 3,000 tons.

b. Assume that the Canadians specialize completely because they figured out they have a comparative advantage in lumber. They are

willing to give up 1,000 tons of lumber. How much oil should they ask for in return for this lumber to be as well off as they were with no trade? How much should they ask for if they want to gain from trading with Venezuela? Note: We can think of this “ask” as the relative price or trade price of lumber.

c. Is the Canadian “ask” you identified in (b) also beneficial for Venezuelans? Use the production possibilities frontier graph for Venezuela to show that Venezuelans can gain from trade.
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