Reasons for Trade
Understanding Production Possibilities
Defining Absolute Advantage
Defining Comparative Advantage
Absolute Advantage Versus Comparative Advantage
Benefits of Specialization
Relationship Between Specialization and Trade
REASONS FOR TRADE
International trade is the exchange of capital, goods, and
services across international borders or territories.
Each nation should produce goods for which its domestic
opportunity costs are lower than the domestic opportunity costs
of other nations and exchange those goods for products that
have higher domestic opportunity costs compared to other
Benefits of trade include lower prices and better products for
consumers, improved political ties among nations, and efficiency
gains for domestic producers.
The production possibilities curve shows the maximum possible
production level of one commodity for any production level of
another, given the existing levels of the factors of production and the
state of technology.
Points outside the production possibilities curve are unattainable with
existing resources and technology if trade does not occur with an
Without trade, each country consumes only what it
produces.However, because of specialization and trade, the
absolute quantity of goods available for consumption is higher than
the quantity that would be available under national economic self-
DEFINING ABSOLUTE ADVANTAGE
A country that has an absolute advantage can produce a good
at lower marginal cost.
A country with an absolute advantage can sell the good for less
than the country that does not have the absolute advantage.
Absolute advantage differs from comparative advantage, which
refers to the ability to produce specific goods at a lower
Even if one country has an absolute advantage in the production
of all goods, it can still benefit from trade.
Countries should import goods if the opportunity cost of importing
is lower than the cost of producing them locally.
Specialization according to comparative advantage results in a
more efficient allocation of world resources.A larger quantity of
outputs becomes available to the trading nations.
Competitive advantage is distinct from comparative advantage
because it has to do with distinguishing attributes which are not
necessarily related to a lower opportunity cost.
ABSOLUTE ADVANTAGE VERSUS
The producer that requires a smaller quantity inputs to produce a
good is said to have an absolute advantage in producing that
Comparative advantage refers to the ability of a party to
produce a particular good or service at a lower opportunity cost
The existence of a comparative advantage allows both parties to
benefit from trading, because each party will receive a good at
a price that is lower than its opportunity cost of producing that
Output per Day of Work
Country A 6 3
Country B 1 2
BENEFITS OF SPECIALIZATION
Whenever countries have different opportunity costs in
production they can benefit from specialization and trade.
Benefits of specialization include greater economic efficiency,
consumer benefits, and opportunities for growth for competitive
The disadvantages of specialization include threats to
uncompetitive sectors, the risk of over-specialization, and
SPECIALIZATION AND TRADE
Nations decide whether they should export or import goods
based on comparative advantages.
Generally, nations can consume more by specializing in a good
and trading it for other goods.
When countries decide which country will specialize in which
product, the essential question becomes who could produce the
product at a lower opportunity cost.
Amounts produced in 12 hours
Bob 6 bottles 4 bottles
Tom 12 bottles 3 bottles
Which of the following is NOT a benefit from international
A) More choices for consumers
B) Increased comparative advantage
C) Improved returns to investment in research and development
D) Improved resource allocation
What is the source of the net benefit from international
A) Comparative advantage
B) Technology spillovers
C) Maximization of consumption
D) Efficient levels of investment
Imagine Russia exports lumber to Norway. Which of the
following describes the price that Norway pays for this
A) It is above Russia's and Norway's opportunity cost of producing
B) It is above Russia's and below Norway's opportunity cost of
C) It is below Russia's and Norway's opportunity cost of producing
D) It is below Russia's and above Norway's opportunity cost of
Which of these determines the location of the production
A) Level of technology
B) Amount of raw materials available
C) All of these answers
D) Amount of labor available
Fill in the blank. The gains from trade enables
_______________ the production possibility frontier.
A) Production outside
B) Consumption inside
C) Consumption outside
D) Production inside
Complete the sentence with the most suitable pairs of
words: (1) is the only sustainable way to consume outside
the PPF curve and (2) allows us to shift the PPF curve outward
in the long run.
A) Efficiency (1); technology (2)
B) Efficiency (1); trade (2)
C) Trade (1); technology (2)
D) Technology (1); efficiency (2)
Imagine Firm A has an absolute advantage in cereal
production over Firm B. If both firms are producing 10 boxes
of cereal an hour, what is true about the marginal cost of the
11th box of cereal?
A) The marginal cost is lower for firm B than firm A
B) The marginal cost is the same for both firms
C) The marginal cost is not related to absolute advantage
D) The marginal cost is lower for Firm A than Firm B
Country A has a comparative advantage over Country B in
the production of corn if ____________.
A) the opportunity cost of producing corn is lowest in Country A
B) the opportunity cost of producing corn is highest in Country A
C) the marginal cost of producing corn is highest in Country A
D) the marginal cost of producing corn is lowest in Country A
Which of the following statements best describes the
implications of comparative advantage?
A) Export goods if they can be produced at a cheaper cost
B) Import goods if the opportunity cost of importing is lower than
the cost of producing them locally
C) Import goods if they can be produced elsewhere
D) Export goods if the opportunity cost of exporting is lower than
the cost of producing them locally
Economic efficiency occurs when all trading partners
A) have the same level of marginal productivity
B) produce the item that they can sell at the lowest cost
C) specialize in the area(s) where they have a comparative
D) All of these answers
Fill in the blank. For a country to have a comparative
advantage in producing good A against another country, it
should be able to produce A ______________.
A) With less labor
B) With less capital
C) At a lower opportunity cost
D) At a lower cost
There are two goods (bread and shirts) and two factors of
production (labor and capital). Bread is capital-intensive,
while shirts are labor-intensive. Country A is abundant in
labor; Country B is abundant in capital. Under free trade,
which is true?
A) Country A will export shirts, while country B will export bread.
B) Country A will export bread, while country B will export shirts.
C) Country A will export both bread and shirts.
D) Country B will export both bread and shirts.
What is the difference between absolute advantage?
A) A country can have a comparative advantage even if it does
not have an absolute advantage.
B) Absolute advantage is necessary for trade, while comparative
advantage is not.
C) Countries with a comparative advantage must have an
absolute advantage, but not vis versa.
D) None of these answers.
Which one of the following is a benefit of specialization?
A) Countries can take advantage of economies of scale.
B) Consumers benefit from lower prices since goods are produced
C) Countries can trade for the good in which they do not have a
D) All of these answers.
What do countries consider when deciding to specialize?
A) Their absolute advantage
B) Their level of economic development
C) Their comparative advantage
D) Their level of efficiency