Illustrating the Gains from Trade
Our discussion so far has emphasized the differences that exist between
individuals, regions, and countries, and how these differences lie behind
the benefits derived from trade. In order to show these benefits more
precisely, we will focus on trade between two countries. We make the
important assumption that within each country the average cost of
production of any good is independent of how much of that good is
produced. That is, we are making the assumption of constant costs. (We
relax this assumption later.) Our example involves two countries and two
products, but the general principles apply to the case of many countries
and many products.
Absolute Advantage
One region is said to have an absolute advantage over another in the
production of good X when an equal quantity of resources can produce
more X in the first region than in the second. Or, to put it differently, if it
takes fewer resources to produce one unit of good X there than in another
country. Table 32-1 shows an example. The two “countries” are Canada
and the European Union (EU), and the two goods are wheat and cloth.
The table shows the absolute cost of producing one unit of wheat and one
unit of cloth in each country. The absolute cost is the dollar cost of the
labour, capital, and other resources required to produce the goods. Thus,