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Absolute and comparative advantage are two important concepts in international trade that largely influence how and why nations devote limited resources to the production of particular goods. Though the global economy is highly complex, the economics of food production offer a straightforward illustration of both of these key concepts.

Though it is not economically feasible for a country to import all of the food needed to sustain its population, the types of food a country produces can largely be affected by the climate, topography, and politics of the region. Spain, for example, is better at producing fruit than Iceland. The differentiation between the varying abilities of nations to produce goods efficiently is the basis for the concept of absolute advantage.

If Japan and the United States can both produce cars, but Japan can produce cars of a higher quality at a faster rate, then it is said to have an absolute advantage in the auto industry. A country's absolute advantage or disadvantage in a particular industry plays a crucial role in the types of goods it chooses to produce. In this example, the U.S. may be better served to devote resources and manpower to another industry in which it has the absolute advantage, rather than trying to compete with the more efficient Japan.

The focus on the production of those goods for which a nation's resources are best suited is called specialization. Given limited resources, a nation's choice to specialize in the production of a particular good is also largely influenced by its comparative advantage. Whereas absolute advantage refers to the superior production capabilities of one nation versus another, comparative advantage is based on the concept of opportunity cost. The opportunity cost of a given option is equal to the forfeited benefits that could have been gained by choosing the alternative. If the opportunity cost of choosing to produce a particular good is lower for one nation than for others, then that nation is said to have a comparative advantage.

Assume that both France and Italy have enough resources to produce either wine or cheese, but not both. France can produce 20 units of wine or 10 units of cheese. The opportunity cost of each unit of wine, therefore, is 10 / 20, or 0.5 units of cheese. The opportunity cost of each unit of cheese is 20 / 10, or 2 units of wine. Say Italy can produce 30 units of wine or 22 units of cheese. Italy has an absolute advantage for the production of both wine and cheese, but its opportunity cost for cheese is 30 / 22, or 1.36 units of wine, while the cost of wine is 22 / 30, or 0.73 units of cheese. Because France's opportunity cost for the production of wine is lower than Italy's, it has the comparative advantage despite Italy being the more efficient producer. Italy's opportunity cost for cheese is lower, giving it both an absolute and comparative advantage.

Since neither nation can produce both items, the most efficient strategy is for France to specialize in wine production because it has a comparative advantage and for Italy to produce cheese. International trade can enable both nations to enjoy both products at reasonable prices because each is specialized in the efficient production of one item.

Okay let's take another step on this topic. Read What are specialization and comparative advantage in international trade? and for visuals, watch Explaining Comparative Advantage.

 

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