comparative advantage

Between two countries, one country can produce goods or services cheaper than the other country, because one country has cheaper and usually more abundant production factors, including labor and capital, for those goods or services. One country typically produces some goods and services cheaper, and the other country produces other goods and services cheaper, because countries differ randomly in production factors. However, one country can produce all goods and services cheaper than the other country. For example, isolated islands can have high costs for everything.

importing

Countries try to get the cheapest and most abundant goods and services for their consumers. With free trade, countries can import needed goods and services that are cheaper than it can make domestically. Countries import goods and services that they make least efficiently and least cheaply, compared to other countries.

exporting

Countries try to expand markets for which they have the cheapest and most abundant goods and services, or higher value for quality, for their producers and for general prosperity. With free trade, countries can export goods and services that they make cheaper and/or that they do not need. They export goods and services that they produce most efficiently and cheapest, compared to other countries.

trade advantage

For two countries and two products, one country can typically produce one product cheaper {trade advantage}, and the other country can produce other product cheaper. Consumers in both countries have more value if they pay less. Producers in both countries have more value if they sell at lowest cost. With free trade, first country can send product in which it has advantage to second country, and second country can send product in which it has advantage to first country. Both countries now pay less for what they need than they pay with no international trade {absolute advantage}, and producers produce most cheaply. See Figure 1, Figure 2, and Figure 3.

production: factor

Countries have labor, capital, and natural-resource production factors, which they can use to produce goods and services. Production factors have production units. Full-time workers are labor production units. Machines are capital production units. Natural-resource production unit is one ton. At any time, countries have numbers of production factors.

Production units in different countries are the same in some ways and different in other ways. For example, natural resources can differ in purity, form, extraction ease, and cost. Machines can differ in quality, form, features, and cost. Average worker can differ in skill, knowledge, strength, and cost.

production: productivity

One production unit can help make many different goods or services. Production units have different efficiencies {productivity, unit} in making different things. For example, one worker can make two tables a day but only one rocking chair. One machine can weld two motorcycles in a day but only one car. One ton of iron can make several motorcycles but only one car.

When production units shift from making one good or service to making another, productivity ratio shows relative original product and new product amounts.

production: opportunity cost

If producer makes good or service, producer and country cannot make different good or service and has opportunity cost. Businesses must choose what to make with available production units. Businesses and countries make goods and services, based on demand. Available production units determine good and service cost and supply. Demand and cost determine prices, and prices affect demand, supply, and opportunity cost.

production: marginal cost

At any time, companies and countries try to use available production units most efficiently, to keep costs low and meet demand. Uses have optimum or lowest production marginal cost for the most recent good or service.

production: lowest marginal cost

Businesses try to make good and service optimum amounts at lowest marginal cost. Countries try to have good and service optimum amounts. At optimum, if any production unit shifts to another product, product cost rises, price rises, demand falls, and then supply and price decrease to where they were before. Other-product cost rises, price rises, demand falls, and supply and price decrease to where they were before. Everything returns to optimum. Other situations result in lower total production, because production optimizes already.

production: cost

Countries have fixed numbers of production units. Production units can make constant good and service numbers. People know relative productivities for producing goods and services in all countries. People know relative costs for producing goods and services in all countries, so people know relative product costs. In each country, goods and services have different costs.

production: product amount

If country has lowest product cost, for same total cost it can make more product than another country.

comparative advantage

Even if country has lower product cost for all products than other country, international trade can be advantageous for both countries {comparative advantage, international trade}|. The country that is better in everything exports the good or service that it makes the most cheaply compared to the other country and that has highest price difference. The country that is worse in everything exports the good or service that it makes almost as cheaply as the other country and that has lowest price difference. See Figure 4 and Figure 5.

For two countries and two products, each country can have higher cost for one product and not the other, or both countries can have higher cost for same product. In both cases, one country exports the product in which it has biggest difference. The other country exports the product in which it has least difference. See Figure 6 and Figure 7.

foreign exchange

For trade, country must sell something to another country to earn foreign currency to buy other country's exports. For only two countries, trade balance must be equal, so selling gets the money for buying. Trade must be reciprocal. Reciprocal trade requires trade advantage, or countries should not trade.

efficiency

International trade allows both countries to be as efficient as possible. Countries can employ all resources, receive the most money, and pay the least. Consumers get the most goods and services, at lowest prices. Workers get highest wages. Countries use resources most efficiently.

For example, each country has one worker each, who can perform 12 hours of work. Countries can make X or Y. See Figure 8.

Businesses maximize productivity. Different workers take different times to make different things. Different workers have different costs. Workers maximize productivity. Idle workers make nothing, so businesses make workers produce something. Workers must work at something, to gain money to buy domestic and/or imported goods, so the only question is: At what do workers work? Workers work where they can gain the most money.

With no trade, workers cannot specialize as much and so cannot get higher income. There is less opportunity and less productivity. With no trade, production must meet domestic needs only. Smaller markets have fewer economies of scale, scarcer resources, fewer workers, and less total money and demand. With trade, cheapest workers work to sell to higher-priced market and make more money.

In second country, workers pay lower prices than with no trade. Workers work to sell more higher-priced items in first country. They make more products than before and so make more money.

First country benefits from that item's increased supply and lower prices. For both countries, overall prices go down, and wages go up.