A country with a comparative advantage in a particular good can produce that good at a lower opportunity cost than a trading partner. This is a good thing for the country in question, because it can then trade that good for other goods. An example of this is coffee, which Maldonia produces in large quantities, while Sylvania produces less quantity, but at a lower opportunity cost.
If Lamponia and Maldonia both produce potatoes, they can trade these two goods for their respective comparative advantages. The two countries agree to exchange 12 million pounds of coffee for 12 million pounds of potatoes. This ratio is known as the terms of trade. The black point represents the amount of coffee that Lamponia will consume after the exchange. The dashed drop lines automatically extend to both axes.
In terms of production, Maldonia and Lamponia have comparative advantages in potato and coffee. The two countries produce 24 million pounds of potatoes and 12 million pounds of coffee respectively. Let’s say that Maldonia has a comparative advantage in producing tea. So, the two countries decide to trade their crops. They decide to exchange eight million pounds of potato for six hundred thousand pounds of coffee. This is called the price of trade.
The countries have a comparative advantage in the production of potatoes and coffee. These two commodities have a higher cost than the goods produced by their trading partners. In fact, it is much cheaper for Maldonia to produce the same quantity of potatoes than Lamponia. If the countries decide to trade, they will exchange 8 million pounds of potatoes for eight million pounds of tea. This is known as the price of trade between the two economies.
In terms of the production of lemons and potatoes, Maldonia has a comparative advantage in these two products. If we compare these two countries, we see that both have a competitive advantage in producing these goods. In coffee, Maldonia is the best-performing country, but it is also the most expensive. If it doesn’t produce enough coffee, it is more expensive than Lamponia. The difference in prices is significant, so the value of a trade between the two countries will be lower.
By contrast, lamponia has a comparative advantage in the processing of potatoes. In coffee, it has a comparative disadvantage in the production of oranges. By comparison, Desonia is the best exporter of tea. Its exports are more expensive than the country’s imports. It is therefore a good idea for Maldonia to focus on its comparative advantage in coffee.
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