Specialization and Comparative Advantage
An economy can focus on producing all of the goods and services it needs to
function, but this may lead to an inefficient allocation of resources and hinder
future growth. By using specialization, a country can concentrate on the
production of one thing that it can do best, rather than dividing up its resources.
For example, let's look at a hypothetical world that has only two countries
(Country A and Country B) and two products (cars and cotton). Each country can
make cars and/or cotton. Now suppose that Country A has very little fertile land
and an abundance of steel for car production. Country B, on the other hand, has
an abundance of fertile land but very little steel. If Country A were to try to
produce both cars and cotton, it would need to divide up its resources. Because it
requires a lot of effort to produce cotton by irrigating the land, Country A would
have to sacrifice producing cars. The opportunity cost of producing both cars and
cotton is high for Country A, which will have to give up a lot of capital in order to
produce both. Similarly, for Country B, the opportunity cost of producing both
products is high because the effort required to produce cars is greater than that of producing cotton.
Each country can produce one of the products more efficiently (at a lower cost)
than the other. Country A, which has an abundance of steel, would need to give
up more cars than Country B would to produce the same amount of cotton.
Country B would need to give up more cotton than Country A to produce the
same amount of cars. Therefore, County A has a comparative advantage over
Country B in the production of cars, and Country B has a comparative advantage
over Country A in the production of cotton.
Now let's say that both countries (A and B) specialize in producing the goods with
which they have a comparative advantage. If they trade the goods that they
produce for other goods in which they don't have a comparative advantage, both
countries will be able to enjoy both products at a lower opportunity cost.
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Furthermore, each country will be exchanging the best product it can make for
another good or service that is the best that the other country can produce.
Specialization and trade also works when several different countries are
involved. For example, if Country C specializes in the production of corn, it can
trade its corn for cars from Country A and cotton from Country B.
Determining how countries exchange goods produced by a comparative
advantage ("the best for the best") is the backbone of international trade theory.
This method of exchange is considered an optimal allocation of resources,
whereby economies, in theory, will no longer be lacking anything that they need.
Like opportunity cost, specialization and comparative advantage also apply to the
way in which individuals interact within an economy. Absolute Advantage
Sometimes a country or an individual can produce more than another country,
even though countries both have the same amount of inputs. For example,
Country A may have a technological advantage that, with the same amount of
inputs (arable land, steel, labor), enables the country to manufacture more of
both cars and cotton than Country B. A country that can produce more of both
goods is said to have an absolute advantage. Better quality resources can give a
country an absolute advantage as can a higher level of education and overall
technological advancement.
It is not possible, however, for a country to have a comparative advantage in everything that it produces, so it will always be able to enefit from trade.
