We know that specialisation occurs at all levels in the global economy (individual division of labour, firms, regions and countries).

If we assume there are only two counties in the world, England and France, each with the same quantity of resources, and they produce only two goods, bread and jam.

England and France devote half of their resources to the production of each of the goods.

We can see from the table below that with a year’s worth of labour in England can produce more bread and jam than in France. England therefore has an absolute advantage in the production of bread and jam.

England is six times as efficient in bread production, but only 50% more efficient in jam production.

If France wishes to produce an extra unit of jam it has to give up half a unit of bread, however if England wishes to produce an extra unit of jam it must give up two units of bread.  A country’s comparative advantage lies in the good that it can produce relatively cheaply, i.e. at a lower opportunity cost than its trading partner.

England (which has an absolute advantage in both commodities) therefore has a comparative advantage in bread production, whereas France has a comparative advantage in jam production.

If each country specialises completely in the good that they have a comparative advantage in, the production totals will be:

Compared to the earlier situation without specialisation and trade, there has been a gain of 25 units of bread, but a fall of 5 units of jam.  We cannot say for sure whether or not there has been a welfare gain as the amount of jam has fallen and we do not know what value consumers place on jam.

In order to demonstrate a welfare gain, a situation must be devised where at least as much of one good and more of another results from specialisation and trade.  We obtain this result, by allowing England to devote one sixth of its resources to jam production, giving production totals that are shown overleaf:

There are a number of assumptions that we have to make when looking at the above example of comparative advantage:

• There are no transport costs.       

• Costs are constant, therefore there are no economies of scale.

• There are only two economies producing goods.          

• Goods are homogeneous in different countries.                        

• Factors of production are completely mobile.

• There are no tariffs or other trade barriers.

• There is perfect knowledge.

We can find analogies in terms of individuals specialising in different tasks.  Some lawyers are better typists than their secretaries, but the secretaries do all of the typing.  The lawyer has an absolute advantage in both practising law and typing, but the secretary has a comparative advantage in typing.

This is because the opportunity cost of the lawyer doing an hours typing is far higher than that of the secretary, therefore it makes sense for the secretary to type and allow the lawyer to practice law.  

Notes on the internet
Benefits of Trade
Benefits of Trade and Protectionism