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

    Global Steel Industry Faces “Severe Winter”

    The global steel industry is in deep crisis due to overcapacity, falling prices and rising competition that has threatened the survival of many companies.
  2. 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 ...
  3. Investing

    United States Steel to Trade Ex-Dividend (X)

    Absent higher steel demand and improving commodity prices, U.S. Steel, even with its solid yield, isn't a value.
  4. 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.
  5. 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.
  6. Insights

    U.S. Steel 'Very Undervalued': Credit Suisse (X)

    The risk-versus-reward profile of United States Steel continues to be a hot topic for investors.
  7. Investing

    AK Steel Stock Get Downgraded by Jefferies (AKS)

    One would need fortitude as strong as steel to invest in steel stocks over the past month.
  8. 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.
  9. Investing

    Assessing Steel Dynamics' Valuation (STLD)

    Despite the 16% one-month plunge in the Market Vectors Steel ETF, names like Steel Dynamics continue to shine.
  10. Investing

    Steel Prices Soaring, Led by China

    Despite a continuous global supply glut, steel prices in China have advanced since the beginning of 2016.
Frequently Asked Questions
  1. What is the difference between yield and return?

    While both terms are often used to describe the performance of an investment, yield and return are not one and the same ...
  2. What are the Differences Among a Real Estate Agent, a broker and a Realtor?

    Learn how agents, realtors, and brokers are often considered the same, but in reality, these real estate positions have different ...
  3. What is the difference between amortization and depreciation?

    Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost be proportionally ...
  4. Which is better, a fixed or variable rate loan?

    A variable interest rate loan is a loan in which the interest rate charged on the outstanding balance varies as market interest ...
Trading Center