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Comparative Advantage MODULE 1.3

and Gains from Trade

In this Module, you will learn to:
• Explain how trade leads to gains for individuals and economies
• Define absolute advantage and comparative advantage
• Use production possibilities curves to determine absolute and comparative
advantages
• Describe how comparative advantage determines how trading partners should
specialize
• Calculate mutually beneficial terms of trade

Gains from Trade

A family could try to take care of all its own needs — growing its own food, sewing its
own clothing, providing itself with entertainment, and writing its own economics text-
books. But trying to live that way would be hard. A much higher standard of living
can be attained for everyone by dividing tasks such that each person provides one or
more goods or services in return for different desired goods and services. This system
describes trade. In a market economy, individuals
The reason we have an economy, rather than many self-sufficient individuals, engage in trade: they provide
is to take advantage of the gains from trade: by dividing tasks and trading, two peo- goods and services to others
ple (or 7 billion people) can each get more of what they want than they could get by and receive goods and services
being self- sufficient. The division of tasks that allows gains from trade is known as in return.
specialization, which allows each person to engage in a task that they are particularly
good at performing. The gains from trade come from
specialization: each person
The advantages of specialization, and the resulting gains from trade, were the specializes in the task that they
starting point for Adam Smith’s 1776 book The Wealth of Nations, which many regard are good at performing.
as the beginning of economics as a discipline. Smith’s book begins with a descrip-
tion of an eighteenth-century pin factory where, rather than each of the 10 workers
making a pin from start to finish, each worker specialized in one of the many steps in
pin-making:
One man draws out the wire, another straights it, a third cuts it, a
fourth points it, a fifth grinds it at the top for receiving the head;
to make the head requires two or three distinct operations; to
put it on, is a particular business, to whiten the pins is another;
it is even a trade by itself to put them into the paper; and the
important business of making a pin is, in this manner, divided
into about eighteen distinct operations. . . . Those ten persons,
therefore, could make among them upwards of forty-eight thou-
sand pins in a day. But if they had all wrought separately and
independently, and without any of them having been educated
to this particular business, they certainly could not each of them
have made twenty, perhaps not one pin a day. . . . Ryan Pyle/Getty Images
The same principle applies when we look at how people
divide tasks among themselves and trade in an economy.
The economy as a whole can produce more when each per- The concept of specialization allows for the mass production of
son specializes in a task and trades with others. most of the devices and appliances that we use today.

Module 1.3 Comparative Advantage and Gains from Trade 19
Copyright © Bedford, Freeman & Worth Publishers.
Strictly for use with its products. For review purposes only. Not for redistribution.

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