In international trade, many students ask me about why bigger countries often appear desperate to trade with poor, smaller states. Well, in order to improve the standards of living for local people, prices must be as low as possible for the best quality; that is why we do not care much about ‘Absolute advantage’ (the ability to produce more than the others) but ‘Comparative advantage’ (the ability to produce it cheaper than others). Countries will then sit down and compare their comparative advantages and see where the cheapest goods can be found.
Example: two countries Alpha and Beta are in a trading bloc and they want to see how they can maximise their benefits from the bilateral trade. They have the following production possibilities/capacities:
| Goods | Alpha | Beta |
| Oil | 100 | 60 |
| Cars | 50 | 40 |
To an ordinary eye, Country Alpha is self-sufficient and has more resources than Beta (Absolute advantage). However, to improve their standards of living, they will need to see if they are paying the lowest price for those goods using comparative advantage:
- Oil =Country A Production possibilities/Country B’s
=100/60
=1.67 (Alpha is 1.67 times better at oil production than Beta)
- Cars =50/40
=1.25 (Alpha might be making more cars but they would be buying them cheaper if they were importing them from Beta)The two governments can later on allow A to supply oil, while B will concentrate on cars since they both have better cost advantages over each other in those goods.
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