The Fifth Principle
Trade involves exchange of goods and services for commercial purposes. Individuals, companies, and nations that engage in trade become better off because they meet each other’s needs. Thus, the fifth principle of economics states that “Trade can make everyone better off” (Mankiw, 2016, p.173). Although Japan and the U.S. compete in the global car market, this does not imply that trade between the two countries becomes a win-loss situation, but rather each country becomes better off by satisfying its customers’ needs. Trade boosts the economic well-being of countries such that the benefits accrued by the winners exceed the losses incurred by the losers.
Trade enables countries to specialize in the production of goods that incur minimum costs and benefits from a variety of products and services from other countries. For instance, Saudi Arabia is one of the core producers of oil in the world. The country benefits from international trade by selling petroleum products to countries that do not produce them, and in return, it imports food and machinery from other countries that specialize in those products. In this case, the countries that export goods to Saudi Arabia would benefit from increased revenue while Saudi Arabia would benefit from gains obtained from a variety of goods that it cannot produce locally.
Opportunity cost is a product an individual is willing to relinquish in order to get another product. According to Mankiw (2016), the opportunity cost depicts a trade-off between two products that every trader faces. For instance, when a trader buys a bundle of bathing soap for $70, the amount that he pays is the opportunity cost since he cannot use $70 to purchase other goods. If the trader had planned to purchase utensils using the same amount of money, he had to forgo the idea of buying utensils and settle for the bundle of bathing soap.
A country that invests on weapons may opt to reduce the amount allocated to security department and increase the budget for higher education. In this case, the opportunity cost is sacrificing the budget for security to boost higher education. If Korea could utilize opportunity cost to direct the money that it invests in nuclear weapons towards manufacturing industry, the country could be better off economically than most countries.
Economists utilize the term comparative advantage to explain the opportunity costs that two producers encounter in the market. Comparative advantage is the capacity to produce a product at a lower opportunity cost when compared to another product (Mankiw, 2016). Comparative advantage is the driving force towards specialization, as no producer can have a comparative advantage on both goods. When each country specializes in manufacturing one product for which it enjoys a comparative advantage, such countries contribute in making everyone better off.
The principle of comparative advantage purports that even though one country is better off at manufacturing certain product than its trading partner, the trading partner country can still produce the same good, but at lower opportunity costs. For instance, the U.S. has a comparative advantage in the production of wheat and dairy products over Canada. If the U.S. could invest less in dairy production, Canada can reciprocate by increasing its investment in dairy production where it will have lower opportunity costs. Both countries can be better off economically, as long as there are restrictions on the capital flow and low transaction costs.
Mankiw, N. G. (2016). Principles of microeconomics. Stamford, CT: Cengage Learning.