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1. What is absolute advantage in trade theory?

Absolute advantage is when an individual/country can produce a product or provide a service for a lower cost per unit using the same number of inputs as another individual/country producing the same product or service. This can happen when there are more product or services produced for the same cost or the same quantity but at a lower cost.

When countries produce products or provide services that they have an absolute advantage in and then trade they will be better off as long as their trade partner is also trading their own advantageous product or services with them.

1. What is the comparative advantage on international trade?

Comparative advantage is when an economy has the ability to make a specific product or provide a service that is lower in opportunity cost than another economy. The economy with the competitive advantage will forego less potential benefit to produce the product or service. This allows the economy with the comparative advantage to sell or export those goods and services at a lower price that its competitors because it cost them less to make it.

1. How does absolute and comparative advantage lead to specialization?

If a country can produce a product or provide a service more efficiently with lower opportunity costs than another then it will export larger quantities of that product or service because other countries will want to import it. The country will therefore export the products with less opportunity costs for them to make and import those products that are higher in opportunity costs to produce for themselves. The exporting company will then specialize in producing that product or service for trade with other countries for the higher opportunity cost products and services.

If a country can produce a product or provide a service more efficiently with lower input costs than another then it will export larger quantities of that product or service because other countries will want to import it. The country will therefore export more of the products with lower costs for them to make and import those products that are higher in costs to produce for themselves. The exporting company will then specialize in producing that product or service for trade with other countries for the higher cost products and services.

Economies of scale will be achieved in economies with either comparative or absolute advantage situations. Economies will produce more of certain products for either comparative or absolute advantage reasons, spreading the costs over larger production runs and thereby lowering costs even more. This specialization will allow each country to mutually gain from tradein producing and selling a specific good or service.

1. What are the benefits of comparative advantage?

• Higher profits - countries that trade products based on a comparative advantage will produce products that have a lower opportunity cost compared to others that they import. By concentrating their labour and resources on producing that product or service they can achieve a higher profit per unit
• Increased efficiencies - by focusing on the comparative advantage product or service they can achieve economies of scale and import the products that are less efficient for them to produce themselves
• Resource reservation - countries will specialize and focus on the products that they have a comparative advantage for and therefore will import the products that are more expensive for them to manufacture thereby saving those resources that would have been used on the imported products

Calculations:

1. The following represents the production possibilities in the following two countries.

Canada Mexico
Good X	Good Y	Good X	Good Y
0	32	0	24
4	24	4	18
8	16	8	12
12	8	12	6
16	0	16	0

1. Which country has a comparative advantage at producing Good X?

Mexico has the comparative advantage over Canada of Good X because its opportunity cost of producing 1 unit of Good X is only 1.5 units of Good Y versus 2 units of Good Y for Canada.

1. How can you tell? (Hint: opportunity cost)

Canada: if they make 1 unit of X it will cost them 2 units of Y (8 / 4 = 2) so (1 X = 2 Y's)

Mexico: but if they make 1 unit of X it will only cost them 1.5 units of Y (6 / 4 = 1.5) so (1 X = 1.5 Y's)

So, when either country produces 4 units of X ... Canada will have to forgo 8 units of Y (2 x 4) whereas Mexico will only have to forgo 6 units of Y (1.5 x 4)

1. Which country has a comparative advantage at producing Good Y?

Canada has the comparative advantage for product Y.

1. Indicate how both countries can gain from trade?

Mexico and Canada would benefit from trade and increase their profits if they specialize in the product that they the comparative advantage for. So, in this scenario Mexico would produce X and Canada would produce Y and they would trade the surplus of these products.

Canada: if they make 1 unit of X it will cost them 2 units of Y (8 / 4 = 2) so (1 X = 2 Y's) So, Canada will trade for X as long as they can get product 1 X for less than 2 units of their Y.

Mexico: but if they make 1 unit of X it will only cost them 1.5 units of Y (6 / 4 = 1.5) so (1 X = 1.5 Y's) And Mexico will trade for Y as long as they get at last 1.5 Y's for 1 of their X product.

The most profitable trade for Mexico and Canada would be 1 unit of X for 1.75 units of Y.

Use the following data to answer the followingquestions: Untied States can produce either 18 oranges or 9 apples in an hour, whereas Mexico can produce either 16 oranges or 4 apples in an hour.

United States	Mexico
Apples	Oranges	Apples	Oranges
9	18	4	16

1. What are the opportunity costs of producing 1 apple for United States and Mexico respectively?

United States: if they produce 1 apple it will cost them 2 oranges

Mexico: if they produce 1 apple it will cost them 4 oranges

3.What are the terms of trade between apples and oranges that would allow both Untied States and Mexico to gain by specialization and exchange?

The United Sates will specialize in apple production and Mexico will specialize in orange production since these products give each country a comparative advantage over the other. If the United Sates can get more than 2 oranges for 1 of their apples and if Mexico can 1 apple for less than 4 of their oranges, they will trade. It would make the most sense for both countries to trade 1 apple for 3 oranges.