The Gains from Trade

Imagine that Ghana exploits its comparative advantage in the production of cocoa to increase its output from 10 tons to 15 tons. This uses up 150 units of resources, leaving the remaining 50 units of resources to use in producing 3.75 tons of rice (point C in Figure 4.2). Meanwhile, South Korea specializes in the production of rice, producing 10 tons. The combined output of both cocoa and rice has now increased. Before specialization, the combined output was 12.5 tons of cocoa and 12.5 tons of rice. Now it is 15 tons of cocoa and 13.75 tons of rice (3.75 tons in Ghana and 10 tons in South Korea). Table 4.2 summarizes the source of the increase in production.

Not only is output higher, but also both countries can now benefit from trade. If Ghana and South Korea swap cocoa and rice on a one-to-one basis, with both countries choosing to exchange four tons of their export for four tons of the import, both

Table 4.2

Comparative Advantage and the Gains from Trade

			Resources Required to Produce 1 Ton of Cocoa and Rice
			Cocoa		Rice
	Ghana		10		13.33
	South Korea		40		20
			Production and Consumption without Trade
			Cocoa		Rice
	Ghana		10.0		7.5
	South Korea		2.5		5.0
	Total production		12.5		12.5
			Production with Specialization
			Cocoa		Rice
	Ghana		15.0		3.75
	South Korea		0.0		10.0
	Total production		15.0		13.75
			Consumption after Ghana Trades 4 Tons of Cocoa for 4 Tons of South Korean Rice
			Cocoa		Rice
	Ghana		11.0		7.75
	South Korea		4.0		6.0
			Increase in Consumption as a Result of Specialization and Trade
			Cocoa		Rice
	Ghana		1.0		0.25
	South Korea		1.5		1.0

countries are able to consume more cocoa and rice than they could before specialization and trade (see Table 4.2). Thus, if Ghana exchanges 4 tons of cocoa with South Korea for 4 tons of rice, it is still left with 11 tons of rice, which is 1 ton more than it had before trade. Moreover, the 4 tons of rice it gets from South Korea in exchange for its 4 tons of cocoa, when added to the 3.75 tons it now produces domestically, gives it a total of 7.75 tons of rice, which is .25 of a ton more than it had before trade. Similarly, after swapping four tons of rice with Ghana, South Korea still ends up with six tons of rice, which is more than it had before trade. In addition, the 4 tons of cocoa it receives in exchange is 1.5 tons more than it produced before trade. Thus, consumption of cocoa and rice can increase in both countries as a result of specialization and trade.

Generalizing from this example, the basic message of the theory of comparative advantage is that potential world production is greater with unrestricted free trade than it is with restricted trade. Ricardo's theory suggests that consumers in all nations can consume more if there are no trade restrictions. This occurs even in countries that lack an absolute advantage in the production of any good. To an even greater degree than the theory of absolute advantage, the theory of comparative advantage suggests that trade is a positive-sum game in which all gain. As such, this theory provides a strong rationale for encouraging free trade. Ricardo's theory is so powerful that it remains a major intellectual weapon for those who argue for free trade.