Gains From Mutual Absolute Advantage

Suppose that New Zealand and Australia have fixed amount of land and do not trade with the rest of the
world. They only have two goods, the wheat for food and cotton for clothing.

Now, assuming that they have 100 acre of land each. New Zealand can produce 3 times of wheat than
Australia and Australia can produce 3 times of cotton than new Zealand. new Zealand has absolute
advantage over Australia in producing wheat and Australia has absolute advantage over new Zealand in
producing cotton. Now we can say that the two countries have mutual absolute advantage.

If there is no trade and each country will divide its land to have an equal unit of cotton and wheat
production. Both countries will have 150 bushels of wheat and 150 bales of cotton. New Zealand will
have to put 75 acres for cotton and 25 acre for wheat. Australia does the opposite.

If new Zealand will use all of its land to wheat production, it can produce 600 bushels of wheat. If
Australia will use all of its land for cotton production, it can produce 600 bales of cotton. Before
specialization and trade, both countries can only have 150 units of both products. But after
specialization and trade, both countries can now have 300 units of both products. Specialization and
trade allowed the countries to double their production!

The advantages of specialization seem obvious when one country is technologically superior of
producing one product and another country is technologically superior of producing another product.

Now lets talk about when one country has an absolute advantage in producing both products.

Gains from Comparative Advantages

For example, New Zealand has an absoluture advantage in producing both products over Australia. With
100 acre of land, It can produce 6 times the production of wheat and twice for the cotton over
Australia. Specialization and trade can still benefit the two countries.

When there is no trade between countries, assuming that people in both countries consumes equal
units of both goods, new Zealand can produce 300 units of bth goods while Australia can produce only
75 units of both goods.

It is shown in stage 1 that Australia has moved all of their production to cotton. It can produce 300 bales
of cotton and 0 wheat.

In stage 2, new Zealand used its ¾ of land for wheat and ¼ for cotton. It can produce 450 units of wheat
and 150 for cotton.