| The principle of free trade is based on the law of | | | | it at a lower opportunity cost. I.e. if it has to forego |
| comparative advantage. The law of comparative | | | | less of other goods in order to produce it. |
| advantage states that if countries specialise in | | | | · Thus trade between countries can still be |
| producing what they have a relative advantage | | | | beneficial even if one country can produce all goods |
| (lower opportunity cost) then there will be a net gain | | | | with less resources. For example a developed |
| to society. This essay is an explanation of the | | | | country may have an absolute advantage in both |
| difference between absolute and comparative | | | | computers and cloth. |
| advantage. | | | | · However the developed country has a |
| Absolute Advantage: | | | | comparative advantage in computers because only a |
| This occurs when one country can produce a good | | | | small amount of cloth has to be foregone. |
| with fewer resources than another. For example if | | | | · The developing country has a higher |
| France can produce wine with less resources than | | | | opportunity cost for computers because it would |
| the UK, then France should specialise in the | | | | have to forego a lot of cloth to produce a computer. |
| production of wine. | | | | Benefits of Trade |
| · If the UK can produce wheat with less | | | | 1. The law of comparative advantage states that |
| resources then it will have an absolute advantage. | | | | trade can benefit all countries if they specialise in the |
| · Therefore UK will specialise in wheat, and | | | | goods in which they have a comparative advantage. |
| France in wine. | | | | As a result consumption increases because of |
| · Production will be maximised by each | | | | specialisation. |
| country specializing and then trading, both countries | | | | 2. Specialisation will result in economies of scale . |
| will gain | | | | Economies of scale occur when increased output |
| Comparative Advantage | | | | leads to lower average costs of production. This is a |
| A country has a comparative advantage over | | | | major feature of globalisation and the specialisation it |
| another in the production of a good if it can produce | | | | enables. |