A general rule of efficiency is that an individual or group should specialize in production activities in which it can operate more efficiently than other entities. This principle is referred to as comparative advantage when discussing international trade theory; it states that the worldwide production output is maximized when each country concentrates on producing goods for which it has lower opportunity costs.

In Figure 5.1, the U.S. is the low-cost producer for wheat, as it only gives up one unit of steel when it produces one unit of wheat. Great Britain is the high-cost producer for wheat, as it must give up two units of steel for each unit of wheat produced. However, Great Britain is the low cost producer for steel, as it gives up only one-half of a unit of wheat for each unit of steel produced. Therefore, the U.S. has a comparative advantage in producing wheat, while Great Britain has a comparative advantage in producing steel. According to the trade efficiency rule, the world will be better off if Great Britain specializes in steel production and the U.S. specializes in wheat production.

An easy way to determine which country has the comparative advantage is to compare the slopes of the production possibility curves. Suppose you have production possibility curves for two countries with product Y and X, and product Y is placed on the y-axis. The country with the most negative slope for product Y will have the comparative advantage with product Y.

Suppose each country specialized in producing the good for which it had a comparative advantage. The U.S. would produce 50 units of wheat per worker and Great Britain would produce 40 units of steel per worker. The combined world output would be 50 units of wheat and 40 units of steel. With no trade, the combined wheat output is 45 units and the combined steel output is 35 units. Clearly the two countries can benefit from trading with one another - the quantity of wheat produced goes up by five units and the quantity of steel produced goes up by five units. Trading offers more efficient production possibilities.

Terms of Trade

Related Articles
  1. Investing

    How China Impacts the Global Steel Industry

    The Chinese economy is having a significant impact on the performance and profitability of steel and mining stocks.
  2. Insights

    United States Steel Upgraded By JPMorgan (X)

    Shares of U.S. Steel climbed as much as 4.22% Monday, reaching a session high of $19.75 after the company's shares were endorsed by analysts at JPMorgan.
  3. Insights

    U.S. Raises China Steel Import Duty Sixfold (SLX)

    The U.S. said Tuesday it would raise import duties on Chinese cold-rolled steel by 522%.
  4. Investing

    Are There Still More Gains For Steel Stocks Ahead?

    The steel sector has rebounded quite nicely over the last few months as investors have looked for value. Given the longer term demand picture, the value is still there and more gains could still ...
  5. Investing

    Is Now The Time To Invest In Steel?

    Recent price drops present long-term opportunities, while many stable ETFs remain attractive. Learn your best options for turning cold hard steel into cold hard cash.
  6. Investing

    2 Reasons to Expect a Soft FQ4 From Steel Dynamics

    While the company is doing a solid job controlling what it can, the overall steel industry continues to soften.
  7. Investing

    Assessing United States Steel's Valuation (X)

    With shares of United States Steel skyrocketing 101% year-to-date, it's safe to say "X" has marked the right spot for many portfolios.
  8. Investing

    AK Steel Falls Favorable Trade Commission Ruling (AKS)

    U.S. steel producer AK Steel Holding Corporation couldn't escape the negative market sentiment Tuesday.
  9. Investing

    The Upcoming Wheat Crisis

    The U99 Fungus is playing havoc on wheat crops in Africa. If it spreads, there could be a real problem.
  10. Insights

    EC-Imposed Chinese Tariffs Boost Steel Stocks (MT)

    ArcelorMittal rose as high as 4.89% on Friday after the European Commission slapped an anti-dumping duty on Chinese steel imports to the European Union.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center