Benefits from trade



Benefits from international trade – Adam Smith

1. Absolute advantage

Assume two countries: RSA and Namibia. RSA can produce 20 units of gold or 10 units of diamonds if all available resources are employed. Namibia can produce 5 units of gold or 15 units of diamonds if all available resources are employed.

| |South Africa |Namibia |

|Gold |20 |5 |

|Diamonds |10 |15 |

▪ RSA produces more gold than Namibia and thus has the absolute advantage in the production of gold. (20 > 5)

▪ Namibia produces more diamonds than RSA and thus has the absolute advantage in the production of diamonds. (15 > 10)

▪ Both countries will specialize in the production of the product that they have an absolute advantage in.

▪ ( RSA will produce 20 units of gold and zero diamonds and Namibia will produce 15 units of diamonds and zero gold.

▪ RSA will export gold to Namibia and Namibia will export diamonds to RSA.

2. Relative / Comparative advantage

Assume two countries: RSA and USA. RSA can produce 20 motorcars or 10 computers if all available resources are employed. The USA can produce 50 motorcars or 20 computers if all available resources are employed.

| |South Africa |USA |

|Motorcars |20 |50 |

|Computers |10 |20 |

▪ The USA has the absolute advantage in the production of both products.

▪ The question is whether beneficial trade is still possible between the two countries.

▪ To answer this, we need to test for relative / comparative advantage.

▪ Motorcars ratio 2 : 5 (The USA produces 2 ½ times more than RSA

Computers ratio 1 : 2 (The USA produces twice as many computers

▪ Since the ratios differ, beneficial trade is possible between the two countries

▪ The USA will specialize in the production of motorcars, producing 50 motorcars and zero computers.

▪ RSA will specialize in the production of computers, producing 10 computers and zero motorcars

▪ RSA will export computers to the USA and the USA will export motorcars to RSA

3. Equal advantage

Assume two countries: RSA and Botswana. RSA can produce 20 units of maize or 10 units of meat if all available resources are employed. Botswana can produce 10 units of maize or 5 units of meat if all available resources are employed.

| |South Africa |Botswana |

|Maize |20 |10 |

|Meat |10 |5 |

▪ RSA has the absolute advantage in the production of both products.

▪ The question is whether beneficial trade is still possible between the two countries.

▪ To answer this, we need to test for relative / comparative advantage.

▪ Maize ratio 2 : 1 (RSA produces twice as many units

▪ Meat ratio 2 : 1 (RSA produces twice as many units

▪ Since the ratios are the same, beneficial trade is not possible.

▪ No trade will take place between the two countries.

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