Trade Between Britain and Portugal

Now suppose that Britain begins to export wool to Portugal in return for Portuguese wine. If the wool sells at Portuguese prices, then each bale of wool will fetch 3 barrels of wine, rather than two as they would at home. Thus, by producing wool for export rather than domestic wine, the British can get their wine for 3.33 man-days of labor per barrel, while domestic wine would cost them 5 man-days per barrel. By importing wine they are getting it at a lower cost.

Conversely, suppose that Portugal exports wine to Britain in return for British Wool. At British prices, two barrels of wine will fetch a bale of wool. But if the Portuguese produce wool at home, they will have to divert labor sufficient to produce three barrels of wine. Thus, The Portuguese get their wool cheaper by producing wine to trade for it than by producing wool at home -- despite the fact that they can produce more wool per unit of labor than the British can.

It seems most likely that the trade will take place at a price somewhere between the extremes. Suppose the price in international trade is two-and-one-half barrels of wine per bale of wool. Then the British gain an advantage by exporting wool -- they get 2 1/2 barrels of wine when they give up a bale of wool, instead of 2 barrels in domestic production. But the Portuguese also gain an advantage: they give up only 2 1/2 barrels of wine for a bale of wool, whereas by domestic production they would give up three.

Thus, both countries get their goods more cheaply through trade. Trade is beneficial to both countries. And this happens despite the fact that both industries are more productive in Portugal. For neoclassical economics, the key point is that Britain has a comparative advantage in wool, even though Portugal has the absolute advantage in both goods. According to the neoclassical theory, every country has a comparative advantage in some goods. When a country trades according to its comparative advantage, it is making the best advantage of its own resources in production for export and for domestic production.

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