6.1 The reasons for international trade

Absolute advantage means producing more with the same resources or using fewer resources for a product. Comparative advantage means producing it at a lower opportunity cost relative to another producer.

Trade can benefit both sides when each specialises according to comparative advantage and the agreed terms of trade allow both to consume beyond their own production possibilities.

If Country A gives up 2 units of cloth to make 1 unit of food while Country B gives up 5, A has comparative advantage in food—even if B can produce more food per worker in absolute terms.

Absolute advantage alone does not determine the trade pattern; calculate opportunity costs before claiming who should specialise.

Specialisation means concentrating resources on a narrower range of products; international specialisation follows comparative advantage. Free trade allows countries to exchange output without protective barriers.

Specialisation can raise productivity through learning and scale, widen consumer choice and let each country consume beyond its own production possibility frontier. Gains depend on transport, reliable institutions, terms of trade and the ability of workers and firms to adjust.

A country specialising in a product with low opportunity cost can export it and import a product it gives up relatively more of, provided the trading price lies between the two opportunity costs.

Free trade gains are not proof that every worker or region gains immediately; the aggregate benefit can coexist with concentrated adjustment costs.

The terms of trade (TOT) index compares an economy’s export price index with its import price index, commonly as export prices divided by import prices times 100.

An improvement means export prices have risen relative to import prices, so a given volume of exports can buy more imports. The welfare effect depends on export and import volumes, elasticities, concentration and who receives the income.

If export prices rise 12% and import prices rise 4%, the TOT improves approximately 7.7% using index ratios, not simply “8 percentage points” in every calculation.

A better TOT does not guarantee a better trade balance: quantities may change, and an export price rise can reduce export volume.

The simple comparative-advantage model assumes, among other things, limited transport costs, competitive markets, known opportunity costs, mobile resources within countries and no harmful externalities.

Real economies have economies of scale, changing technology, imperfect competition, trade costs, environmental damage and workers who cannot move quickly between sectors. These factors can change the size or distribution of gains.

A cheap imported product may reflect genuine efficiency, but if its production creates unpriced pollution, the market price understates the social cost and the simple welfare conclusion is incomplete.

A model’s conclusion is conditional, not a guarantee that every observed trade pattern or policy follows directly from comparative advantage.