Objectives of this Chapter

We start this chapter by introducing the idea of comparative advantage to describe why two people named Bjørn and François may want to trade. The example shows that when people have different skills in the production of two goods, both can enjoy an increase in their standard of living if they specialize in the production of the good in which they have a relative cost advantage (i.e. a comparative advantage) and then trade. This outcome is possible because, when people have different skills, specialization is efficient and leads to higher total output. The example highlights the potential benefits of any kind of specialization and trade: Bjørn and François can be two neighbors in the same community or can represent the working populations of two countries such as Norway and France.

The chapter continues by noting that trade does not always involve (on-net) exchange of goods for goods, but sometimes goods for assets. We introduce the idea of current accounts (surplus or deficit of goods-for-goods trade) and capital accounts (surplus or deficit of assets-for-assets trade) and describe why simple accounting requires that the current and capital accounts sum to zero. We then show data on the current account – exports, imports, and net exports – in the US in 1929–2007.