Let us quickly review some key points from section 1, the Production Possibilities Frontier (PPF), for a hypothetical country.
We expand from our closed economy to one that includes the trade of goods with another country. Our model will remain simple. We will expand from two goods and one country to two goods and two countries. By allowing for trade we can explain the concepts of specialization and comparative advantage.
In our model, specialization results in each country producing only one good; the good in which they have a comparative advantage in production. In this section we will go through a few steps to determine comparative advantage, but keep things at an intuitive level. Many of us have an aptitude in certain areas. Some individuals may be good at and enjoy engineering, or perhaps writing or some other occupation. For example if he had never picked up a basketball, Michael Jordan may have become an excellent doctor. But given his immense physical skills and the knowledge he developed of basketball, he has a comparative advantage in playing basketball in contrast to your typical M.D. Although Jordan could have chosen other occupations, he choose to specialize in what he has a comparative advantage in. Many of us go to college for the same reason. To gain the skills so that we can specialize in a certain area such as engineering, law, education and so on. If you have little musical talent, you probably won't choose to peruse a career in music over something that you are more talented in.
Just as many individuals end up with a specialty, countries also develop specializations for reasons such as climate or tradition. France is known for its wines, Scotland for its wool, South Africa for diamonds, Japan for electronics and automobiles and the United States for high technology and aviation. The model developed in this section will give an understanding of the determination of comparative advantage and the underlying fundamentals for the trade of goods and services.
Once we determine comparative advantage, we examine the benefits received to both countries from free trade. By free trade, it is implied that there are no trade barriers such as tariffs that act as a tax on imports and raise their prices to consumers. One concept to be emphasized is that trade is not a "you win, I lose" deal. It is a win-win situation for the participants.
Perhaps the most important concept that can be emphasized in a course in economics is that by working together, we all gain. Too often, people and nations have the misguided perception that someone else's gain will come at their expense. Such beliefs are perpetuated by special interests and selfish individuals, politicians and organizations that promote stereotypes and myths. This propaganda leads to discrimination and persecution. If nothing else, this course should teach that when we all work together and provide equal opportunities for all, all have the potential to become better off in an economic sense. This concept will be developed in section 3 with some examples.
Finally, in this section we pull a rabbit out of a hat. By following the guidelines of specialization and trade, the overall level of consumption possible in a country will increase over the constraints imposed by the domestic production possibilities frontier. The consumption possibilities frontier is created by allowing for international trade and lies outside the domestic PPF. The significance of this relationship is that with trade, greater amounts of goods can be consumed in the trading countries than if they relied solely on domestic production.
LINK TO MAIN SECTION OF UNIT 2 - COMPARATIVE ADVANTAGE AND TRADE