Question

Under what conditions does comparative advantage lead to gains from trade?

Short answer

Comparative advantage leads to gains from trade when the following conditions are met: (1) existence of a comparative advantage in at least one good or service between trading partners, (2) specialization in producing goods with comparative advantage, (3) trade between countries based on comparative advantage, (4) both parties experience gains from trade, (5) absence of trade barriers, and (6) factor mobility to shift resources efficiently among sectors with comparative advantage. These conditions enable increased production and consumption, benefiting both trading partners.

Step-by-step solution

1. Comparative advantage

First, ensure there is a comparative advantage in at least one good or service between the trading partners. This means that one country or individual should have a lower opportunity cost of producing a particular good or service compared to the other trading partner.

2. Specialization

Specialization occurs when the country or individual focuses its resources on producing goods in which it has a comparative advantage. This allows them to maximize their production potential and leads to increased efficiency in the use of resources.

3. Trade between countries

Once specialization occurs, countries will seek to trade with others to obtain goods and services for which they have a comparative disadvantage. This trade should be based on the principle of comparative advantage, with each country exchanging the goods in which they have a lower opportunity cost for the ones in which they have a higher opportunity cost.

4. Both parties gain from trade

If both countries can gain from trade, this trade will lead to an increase in overall production and consumption. The gains from trade are realized when the combined output of the trading partners, after specialization and trade, is higher than the output that each country could achieve independently without trade.

5. Absence of trade barriers

For the comparative advantage to lead to gains from trade, it is necessary to have an absence of trade barriers such as tariffs, quotas, or other restrictions that can limit the benefits of trade between countries. These barriers may prevent countries from obtaining the goods in which they have a comparative disadvantage or hinder their efficient production and allocation of resources.

6. Factor mobility

Factor mobility is the ability of resources (labor, capital, etc.) to shift from the production of one good or service to another. This mobility is necessary for countries to re-allocate resources efficiently to sectors where they have a comparative advantage in production. If this condition is present, then comparative advantage is more likely to lead to gains from trade. In conclusion, comparative advantage leads to gains from trade when there's at least one good or service in which one trading partner has a comparative advantage, allowing for specialization, trade based on comparative advantage, gains for both parties, absence of trade barriers, and factor mobility.