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IAI Actuarial Core Principles · Business Economics · Importance of international trade

Two countries, A and B, each have a comparative advantage in one good and specialise accordingly. Which outcome best describes the standard gains from trade?

Both countries can consume outside their own production possibility frontiers. When terms of trade lie between the two domestic opportunity costs, each country gets the imported good at lower cost than producing it at home, so both gain and trade is not a zero-sum game.

  1. ABoth countries can consume beyond their own production possibility frontiers, because trade at an intermediate relative price lets each obtain the other good at less than its domestic opportunity costCorrect
  2. BOnly the country with an absolute advantage in both goods gains from trade
  3. CTotal world output falls, but each country's employment rises
  4. DEach country gains only if the terms of trade equal its own domestic opportunity cost
  5. One country's gain must exactly equal the other country's loss

Explanation

With specialisation and trade at terms of trade between the two domestic opportunity costs, each country obtains imports more cheaply than it could produce them. This allows consumption outside its own frontier. If terms equal a country's domestic opportunity cost, that country gains nothing, so that option is wrong. Trade is not zero-sum.

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