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. Investing

    Top 4 Steel Stocks of 2017

    Trump's plan to use US Steel for all new and pipelines and pipeline repairs position these four steel stocks to break out soon and have a stellar 2017.
  3. 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 ...
  4. 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%.
  5. Investing

    Trump's Wall Could Be Great News for Steel Stocks

    So Trump signed the order for the Wall. Some industries stand to gain. A lot.
  6. Investing

    Steel Stocks Reach 52-Week Highs on Trump Rally (AKS, NUE)

    Several steel manufacturers soared to 52-week highs on Tuesday, as did the Market Vectors Steel ETF.
  7. Trading

    The 2016 Outlook for Wheat and Oat Futures

    Oats futures shows greater upside potential than wheat futures in 2016.
  8. Investing

    Steel Cycle Looks Good

    Buying cyclical stocks at the right time can be a great investment strategy, but it requires more than just trying to time a cycle to benefit.
  9. Investing

    Why AK Steel Stock Surged 32% Last Week (AKS, SLX)

    Steel manufacturers posted strong gains last week in the wake of Donald Trump's surprise victory for the White House.
Frequently Asked Questions
  1. What are the primary differences between a closed end investment and an open end investment?

    Learn what the primary differences are between open-end investments and closed-end investments, and the implications for ...
  2. Why is Ireland sometimes referred to as a tax haven?

    Learn why Ireland is a desirable location for corporations, how low the country's tax rate is and what taxation and economic ...
  3. What is the history of binary options?

    Discover the history of binary options trading, which is now one of the fastest growing investment market vehicles available ...
  4. How did Richard Branson make his fortune?

    Learn how Virgin Group tycoon Richard Branson earned his billions. Follow his journey from Virgin Records to the corporate ...
Trading Center