A country is said to have comparative advantage when it can produce a fixed amount of good with a fixed amount of input but at a lower opportunity cost than other countries it shares trading relationship with and thus there will be gains from trade in comparative advantage. Therefore, advantage in production of any good puts a country in a situation where it can trade the goods with its trading partners and in return receive the goods in which the trading partner has comparative advantage. The notion of this economic theory is that if every country produces the good in which it has comparative advantage then the overall output of the world will be maximum at the expense of minimum resources. To understand the concept of comparative advantage in more detail considering the case of two countries namely Australia and Argentina. Suppose, by employing 50 workers Australia can produce either 1000000 bananas or 50000 mobile phones and by employing same number of workers Argentina can produce 1200000 bananas or 30000 computers. The given table below can express the comparative advantage of the two countries.
|Country||Banana produced by employing 50 workers||Mobile phone produced by employing 50 workers|
From the table it can be said that if Australia and Argentina both employs 50 workers in production of banana then the total production of banana will be 2200000 but there will be no production of mobile phones. On the other hand, if both the countries employ 50 workers in production of mobile phones then 80000 mobile phones will be produced but production will be nil. However, it is necessary to produce both the products and thus it is necessary to find the efficiency of the countries in production of bananas and mobile phones. The efficiency of the countries can be calculated by using the opportunity cost method. Therefore, the opportunity cost of producing banana in Australia is or and of producing mobile phone is 20. Similarly, opportunity cost of producing banana in Argentina is or and of producing mobile phone is 40. Therefore, it is clear that economy will be benefitted by producing banana in Argentina and mobile phones in Australia as amount of products will be maximized. However, this will be beneficial if both the countries share trade relations as comparative advantage can be accrues only by trading otherwise both the countries have to produce both the goods domestically.
A country can produce more goods in which it has specialization and thus producing and trading such good will fetch more profit for the country. Suppose, country A has specialization in production of computers and country B has specialization in production of cars. Both the countries have demand for other goods thus if the economy is closed in the countries then they have to allocate inputs to produce others goods too. However, if trade occurs between the countries A and B then they can employ more workers in production of their specialized product and thus can increase the output of the economy.
There is no country in the world that can produce all the goods it requires, thus if a country trade with other countries then it can allocate its input in the production of specialized good and can purchase other goods from other countries. Trade also improves the allocation of inputs because by participating in trade countries can employ their inputs accordingly in the production of goods in which they have specialization. Hence, more the countries participate in trade more will be the allocation of inputs in specialized product and there will be more production with minimum employment of inputs. These are the reasons that attract gains from trade.
Specialization and trade are directly related to each other, more is the specialization of a country in production of a certain product more will be the demand for that product in the foreign market. On the other hand, trade also encourages a country to produce its specialized product since by trading a country can meet its requirement of other product by importing from the foreign countries and thereby increase the employment of input in the specialized product. Trade thus maximizes the output of the world economy by allowing the countries to invest in the products they have specialization in and there by promotes efficient use of resources.
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