Extension Activity 7p: Trade and comparative advantage
- Australia’s abundance of natural resources and generally good climatic conditions means that the value we can derive from our land is high compared to many other countries with less abundant resources. The sheer volume of mineral resources beneath the ground means that for any given level of capital equipment necessary to extract more will yield more output than most other countries. Similarly, our vast agricultural resources unable more output to be yielded from any given level of capital and labour inputs. This results in Australia being a relatively efficient and dominant producer of commodities in the global marketplace.
- Absolute advantage will occur when a country is more efficient at producing particular goods and services than other countries in the sense that it can produce at lower costs.
- Comparative advantage, in contrast to absolute advantage, means that a country is more efficient at producing particular goods and services than other countries in the sense that it can produce at a lower opportunity cost.
- Country A has a comparative advantage in the production of computers. This is because for every computer that is produced it only has to forego the opportunity of producing 2/3 of a chair. In contrast, for every computer that country B produces it will need to forego the opportunity to produce 1 chair. Given that 2/3 is less than 1, country A has a lower opportunity cost associated with computer production and therefore it has a comparative advantage. Country B has a comparative advantage in the production of chairs. This is because for every chair that is produced it only has to forego the opportunity of producing one computer. In contrast, for every chair that country A produces it will need to forego the opportunity to produce 1½ computers. Given that 1 is less than 1½, country B has a lower opportunity cost associated with chair production and therefore has a comparative advantage.
- If neither country traded (and assuming that the given combination of computers in chairs was based on 100% of each country’s resources being used in the production of each good) then the total production of computers would be 20 (15+5) and the total production of chairs would be 15 (10+5). However, if each country specialises in the production of the good in which they have comparative advantage, then the production of computers would be 30 (all produced by country A) and the production of chairs would be 10 (all produced by country B). Accordingly, ‘global’ production increases from a total of 35 (computers and chairs) to a total of 40 simply as a result of specialization. It therefore makes sense for country A to specialise in the production of computers and country B to specialise in the production of chairs and for both countries to trade such that country A buys chairs from country B and country B buys computers from country A.