Comment on the Significance of Comparative Advantage in Determining the Pattern of World Trade

Comparative advantage is where one country produces a good at a lower opportunity cost than another. The opportunity cost in this case is the cost of production of one good in terms of sacrificed output of another.

The way the theory determines the pattern of world trade is that countries decide to specialise in production of goods where they have comparative advantage. They should then be able to export the surpluses that they produce and use that to fund imports of goods they don’t specialise in as other countries have comparative advantage in that good. This makes trade a positive sum game with mutual benefits of increased economic growth, consumption, consumer choice and living standards. Also if the terms of trade are agreed between the two countries’ opportunity costs then they can consume outside their own PPC and on the trading possibility curve (TPC), and we see this happen all around the globe.

The theory also says that what should happen is inter industry trade where firms and countries within different industries that both have comparative advantage in goods they produce and specialise in should trade which does take place. There is also comparative advantage to a certain degree with intra industry as, although they are in the same industry, they have differentiated products. If this was not the case then there would be no point in trading. So with differentiated products such as midrange cars produced in Germany and mass market or high end cars produced in the UK, they both have comparative advantage in that type of good, so it would still make sense for the two countries to trade.

However on the other hand, certain aspects of trade flows don’t reflect the theory of comparative advantage. There is intra-regional trade where there is trade between countries in the same geographical region. With comparative advantage it would suggest that that there is no obvious link between trade and geography but, this is a common feature of modern trade. The...