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P OK, so today we’re going to start on the "introduction to Trade" topic. I want to start by looking at what exactly we know about trade. What IS trade? Can anyone tell me?
S Um ... well, it’s an exchange. An exchange of goods or services between two regions or countries.
P Yes, that’s right. Historically, well ... the original form of trade was "barter". I’m sure you’ve all heard that word before, but nowadays, "barter" is used to mean "to haggle" or "to bargain" but bartering was originally the exchange of one good or service for another. It’s used a lot in societies where no monetary system exists or in countries where the economy is really unstable. Nowadays traders usually carry out transactions using some medium of exchange, such as money. OK. So we have a basic idea of WHAT trade is, but trade has become such an integral part of our society that few people stop to ask WHY trade exists. What are the benefits of trade? Why do we trade? Any suggestions?
S Maybe because different places specialize in producing different products? Or because different raw materials are available in different countries?
P Yes, that is part of it, but I want to think more in terms of how each party benefits from trade. OK, let’s take a simple example. Imagine two men have just come adrift on a desert island. One of the men is in his late sixties, he’s been ... let’s say a bank clerk all of his working life and isn’t particularly sporty, OK? The other guy’s in his twenties and has been brought up working on a farm. He’s strong, fast and well-informed when it comes to the great outdoors. The two men decide to organize the chores that need to be done. They need to collect water, build shelter, maybe go fishing and collect fruit. It’s clear that the younger man can do all of these tasks better and faster than the older man. He has what’s known as an "absolute advantage" in all of the activities. We use the term "absolute advantage" if a country can produce a particular product or good more cheaply than another or if it can produce more of the good than another country can, with the same resources. OK, so back to our happy campers on the island. The younger man has an "absolute advantage" and could do all of these activities single-handedly, without having to share the results. But he doesn’t. Why not?
S Maybe because ... well, even though the old man can’t work as fast as the young man, he still contributes something. I mean, he can still help and that contributes to the overall production. You know ... many hands make light work! So the young guy could do what he was best at, and the older man could do what he wasn’t so bad at. They could both specialize in one thing. Maybe the young man could carry the water and the old man could go fishing which is less strenuous.
P Great, yes! You’re definitely thinking along the right lines! Let’s look at that concept in more detail. What you’ve just mentioned there is what we call "comparative advantage". "Comparative advantage" is central to modern trade theory and is most commonly used in international trade. "Comparative advantage" is also known as "Ricardo’s Law" and it explains why it’s beneficial for two parties to trade even though one of them may be able to produce every item more cheaply than the other. It’s the ratio between how easily two countries can produce different goods that’s important and not the absolute cost of production. The theory of "comparative advantage" is attributed to David Ricardo although it was first described by Robert Torrens in 1815 in an essay on the corn trade, but we’ll look at that later on. Let’s consider the example Ricardo used. Ricardo used an example involving England and Portugal. Producing both wine and cloth does not require as much work in Portugal as it does in England. In England, it’s not easy to produce cloth and even less so to produce wine. By contrast, Portugal can produce both easily. At first glance, it’s difficult to see why Portugal would want to trade with England but look at it this way. If Portugal just concentrates on producing wine and produces enough to be able to export it to England, and if England focuses on making cloth and exchanges that for cheaper Portuguese wine, both countries benefit. Portugal doesn’t have the cost of making cloth and England benefits from cheaper Portuguese wine. So, according to comparative and not absolute advantage, the younger man on the desert island should concentrate on the activities that he excels at and the older man on the activity he finds the least challenging. In this way, together they increase total production and decrease total labor.
S They could both specialize in one thing: Maybe the young man could carry the water and the old man could go fishing which is less strenuous.
p  Great, yes! You’re definitely thinking along the right lines! Let’s took at that concept in more detail.
What can be inferred about the student based on the professor’s comment?