Question

What does the term "absolute advantage" mean? What is the “principle of comparative advantage”? Explain why the principle of comparative advantage is relevant to international trade policy. Is everyone better off when trading is allowed?

Answer 1

Absolute advantage refers to a situation where a country is better at producing a good such that it requires less labour or other inputs to produce the good than another country. The principle of comparative advantage refers to a situation where a country may not require less inputs to produce the good but it the opportunity cost of producing the good is less compared to the other country. Here, the opportunity cost is in terms of the amount of other goods that are to be sacrificed to produce that good. It is relevant to the international trade policy because it indicates that even when a country requires more inputs to produce all goods i.e. it has an absolute disadvantage in producing all goods, it still can gain from trade since it has a comparative advantage in producing some good. Each country must specialize in the good in which it has a comparative advantage and this way trade can benefit all countries.