4.2 Why Do Nations Trade?
Why does Canada import automobiles, steel, digital phones, and apparel from other countries? Why don’t we just make them ourselves? Why do other countries buy wheat, chemicals, machinery, and lumber products from us? Because no national economy produces all the goods and services that its people need. Countries are importers when they buy goods and services from other countries; when they sell products to other nations, they’re exporters (we’ll discuss importing and exporting in greater detail later in the chapter). The monetary value of international trade is enormous. In 2022, the total value of worldwide trade in merchandise and commercial services was USD $31 trillion (World Trade Organization, 2023).
Absolute and Comparative Advantage
To understand why certain countries import or export certain products, you need to realize that every country (or region) can’t produce the same products. The cost of labour, the availability of natural resources, and the level of know-how vary greatly around the world. Most economists use the concepts of absolute advantage and comparative advantage to explain why countries import some products and export others.
Absolute Advantage
A nation has an absolute advantage if (1) it’s the only source of a particular product or (2) it can make more of a product using fewer resources than other countries. Because of climate and soil conditions, for example, France had an absolute advantage in winemaking until its dominance of worldwide wine production was challenged by the growing wine industries in Italy, Spain, the United States, and more recently, Canada. Unless an absolute advantage is based on some limited natural resource, it seldom lasts. That’s why there are few, if any, examples of absolute advantage in the world today.
Comparative Advantage
How can we predict, for any given country, which products will be made and sold at home, which will be imported, and which will be exported? This question can be answered by looking at the concept of comparative advantage, which exists when a country can produce a product at a lower opportunity cost compared to another nation. But what’s an opportunity cost?
Opportunity costs
Since resources are limited, every time you make a choice about how to use them, you are also choosing to forego other options. Economists use the term opportunity cost to indicate what must be given up to obtain something that is desired. A fundamental principle of economics is that every choice has an opportunity cost.
- If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss.
- If you spend your income on video games, you cannot spend it on movies.
- If you choose to marry one person, you give up the opportunity to marry anyone else.
In short, opportunity cost is all around us.
The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportu