International trade is embraced by countries due to many benefits. In this lesson, we will discuss the differences between comparative and absolute advantage and the importance of specializing in production.
Most consumers don't really think about why their country participates in international trade, or the exchange of goods and services between countries. For example, how often do you stop and think about where your coffee, mangoes, bananas, automobile, clothing, toys and technology products come from?
Does trading help a country's economic structure? In this lesson, you will learn how countries benefit from trade by understanding the differences between comparative and absolute advantage.
When a country is more productive and efficient at making a product than any other country, it is said to have an absolute advantage. In other words, a country with an absolute advantage has the ability to produce more of a product using less of the resource than another country. Let's take a look at a hypothetical example to illustrate the concept. China has an absolute advantage regarding the production of rice. This means that China can produce rice more efficiently and with a lower marginal cost, which is the cost of producing one more of the product.
The lower marginal cost occurs due to a number of different advantages such as cheaper labor or materials. When a country has an absolute advantage over another, they specialize, or devote all of their resources into a few select products. For example, the United States is known to specialize in technology products, and other countries import these products due to the absolute advantage that exists for the U.S.
International trade is also beneficial to countries with comparative advantages. The idea is that every country should specialize in the production of products where they have a comparative advantage through lower opportunity cost. Countries will import goods if the opportunity cost of importing is lower than producing domestically. A lower opportunity cost is the cost of a missed opportunity and the loss of the benefits. For example, the U.S. has access to a plentiful supply of oranges, so they make orange juice. Brazil does not have easy access to oranges, but they do have an abundant coffee bean supply. It would make more sense for Brazil to import orange juice and not miss the opportunity to produce coffee. So, due to its location and resources, the U.S. has a comparative advantage over Brazil with oranges, and Brazil has a comparative advantage with coffee.
Absolute and Comparative Differences
Now that you have a good understanding about both types of advantages, let's reflect on the differences between the two terms. Absolute advantage is based on the advantage of cost, while comparative advantage is focused on opportunity cost. Countries can have absolute advantages in multiple products. In the end, absolute advantage is important to international trade, but comparative advantage will determine which products a country will specialize in producing in the marketplace.
International trade, or the exchange of goods and services between countries, is based on the foundations of economic advantages. A country that is more productive and efficient at making a product than any other country is said they have an absolute advantage. In other words, a country with an absolute advantage has the ability to produce more of a product using less of the resource than another country. International trade is also beneficial to countries with comparative advantages. The idea is that every country should specialize in the production of products where they have a comparative advantage through lower opportunity cost, and that is why countries such as Brazil specialize in producing coffee, and why the United States produces technology products.
When this lesson is finished, you should be able to:
- Define international trade
- Describe how a country may have absolute advantage
- Recognize what a comparative advantage for a country may be
- Identify the differences between comparative and absolute advantages