Comparative Advantage and Trade

Overview

Description

Comparative advantage and trade impacts the stakes in a global economy where virtually all nations engage in trade and interact economically. A comparative advantage occurs when one party has a lower opportunity cost for producing a good than another party. Most countries have an array of trade connections with many other countries. Therefore, a significant level of global competition exists. This raises the question of how smaller countries whose economies are relatively weak can still participate in and benefit from trade in the global economy. The microeconomic concept of comparative advantage helps explain this issue and shows the fundamental processes of trade and the decisions that drive production.

At A Glance

  • Trade is the selling and buying of goods or services.
  • Absolute advantage describes the circumstances in which a country has the highest productivity or, in other words, requires the least amount of input to produce a unit of output.
  • Comparative advantage describes the situation in which a country or person has a lower opportunity cost for each unit of output than a competitor.
  • Countries can benefit from comparative advantage when making free trade agreements.
  • Specialization occurs when each country produces the product for which it has a comparative advantage, leading to maximized output.
  • The benefits of trade include specialization and the ability to obtain needed resources, which can increase a country's overall level of output.
  • Unequal trading power can lead to abuse by more powerful nations. Comparative advantage often overlooks certain costs and can lead to structural unemployment, in which potential employees do not have the required skills and thus remain unemployed. Comparative advantage can change over time.