Question

Which statement is true? (LO3) a) Comparative advantage is not necessary for trade to take place, but absolute advantage is. b) Absolute advantage is not necessary for trade to take place, but comparative advantage is. c) Both absolute and comparative advantage are necessary for trade to take place. d) Neither absolute nor comparative advantage are necessary for trade to take place.

Short answer

The correct statement is (b) Absolute advantage is not necessary for trade to take place, but comparative advantage is. This is because trade can be carried out even when a country has zero absolute advantage but a comparative advantage.

Step-by-step solution

Understanding terms

To proceed with this task, it's necessary to fully understand both concepts: - Absolute advantage: A country has an absolute advantage if it can produce a good at a lower cost than another country. - Comparative advantage: A country has a comparative advantage if it can produce a good at a lower opportunity cost than another country.

Analyzing the statements

Look at each statement and apply the definitions of absolute and comparative advantage. a) Comparative advantage is not necessary for trade to take place, but absolute advantage is. This statement is not always true, as sometimes a country with no absolute advantage will trade to get products it could not produce efficiently. b) Absolute advantage is not necessary for trade to take place, but comparative advantage is. This statement is generally accepted as true, because even when a country has no absolute advantage, it could still have comparative advantage and can benefit from trade. c) Both absolute and comparative advantage are necessary for trade to take place. This is not always true. Even if a country does not have an absolute advantage, it could still trade based on comparative advantage. d) Neither absolute nor comparative advantage are necessary for trade to take place. This statement is not true. Though absolute advantage is not necessary for trade, the concept of comparative advantage is vital in justifying and explaining why trade between countries takes place.

Choosing the correct answer

The correct statement is (b) Absolute advantage is not necessary for trade to take place, but comparative advantage is. Because trade can be carried out even when a country has zero absolute advantage but a comparative advantage.

Key concepts

Absolute Advantage

Imagine a scenario where two countries, let's call them Country A and Country B, are both producing the same good, say, cotton. Country A can harvest and process 1000 bales of cotton using the same resources it would take Country B to produce only 800 bales. In this case, Country A has an absolute advantage in producing cotton because it can produce a greater quantity with the same inputs or the same quantity with fewer inputs.

Moreover, the concept of absolute advantage extends beyond raw production numbers; it considers the cost of production in terms of resources. As such, if Country A uses less labor, capital, and land to grow its cotton than Country B, it still holds an absolute advantage. This aspect emphasizes efficiency and cost-effectiveness.

Despite its implication of superior productivity, having an absolute advantage is not a prerequisite for a country to engage in international trade. Trade is influenced more by relative efficiencies, as explained through the lens of comparative advantage, discussed in the next section.

International Trade

Moving into the realm of international trade, it's essential to appreciate how it boosts global economic activity. International trade allows countries to expand their markets, offering goods and services to a larger base of consumers and businesses. It is the fabric that connects nations, allowing them to specialize in producing goods where they hold a comparative advantage and to import goods in which they are less efficient.

Trade agreements and tariffs are part of the complex mechanisms that regulate international trade. Furthermore, the theory of comparative advantage is crucial because it explains why even countries without an absolute advantage will find it beneficial to trade. The primary goal of such trade is to maximize economic efficiency by allowing countries to leverage their specializations and lower their opportunity costs, as will be detailed in the following section. International trade, when conducted under favorable terms for all parties involved, can lead to increased efficiencies and economic growth for every country involved.

Opportunity Cost

The concept of opportunity cost is fundamental to understanding comparative advantage and its role in international trade. Opportunity cost refers to the potential benefits an individual, investor, or nation misses out on when choosing one alternative over another. In the context of international trade, it translates to the cost of forgone products that a country does not produce because it decides to specialize in something else.

For example, if Country A decides to allocate more resources to producing cars instead of cotton, the opportunity cost is the amount of cotton not produced. The principle of comparative advantage proposes that each country should specialize in the goods for which it has the lowest opportunity cost, thereby maximizing its efficiency and gains from trade.

Therefore, in an optimal trade scenario, countries will specialize in the production and exportation of goods with the lowest opportunity cost, and import goods that would have a higher opportunity cost if produced domestically. This strategy ensures that resources are allocated in the most efficient manner possible, benefiting all countries involved in the trade.