Suppose the USA and Canada are considering to trade. Assume there are only two goods in the economy: wheat and corn. The table below illustrates what each country can produce in a given year.
Wheat Corn
USA 4 2
Canada 5 8
In this case, which country should produce wheat? Why? Hint: CALCULATE THE OPPORTUNITYCOST FOR EACH COUNTRY. For instance, USA can produce 4 units of wheat OR 2 units of Corn. In this case, if the USA produces one unit of corn, then it has to give up 2 units of wheat.
To determine which country should produce wheat, we need to compare the opportunity cost of producing wheat for each country.
Opportunity cost is the value of the next best alternative that is forgone when a choice is made. In this case, the opportunity cost of producing wheat is the number of units of corn that each country would have to give up to produce one more unit of wheat.
Let's calculate the opportunity cost for each country:
For the USA:
- The USA can produce 4 units of wheat or 2 units of corn.
- To produce one more unit of wheat, the USA would have to give up 2 units of corn.
For Canada:
- Canada can produce 5 units of wheat or 8 units of corn.
- To produce one more unit of wheat, Canada would have to give up 8/5 units of corn, which is equivalent to 1.6 units of corn.
Comparing the opportunity costs, we see that the USA has a lower opportunity cost for producing wheat (2 units of corn) compared to Canada (1.6 units of corn). Therefore, the USA should specialize in producing wheat because it has a comparative advantage in its production.
In international trade, countries should specialize in producing goods in which they have a comparative advantage. By specializing in the production of wheat, the USA can maximize its resources and efficiency, while Canada can specialize in producing corn, where it has a lower opportunity cost. This allows both countries to benefit from trade by exchanging goods in which they have a comparative advantage.