Final answer:
The power of trade and comparative advantage work by raising the average wage rate economy-wide while reducing the incomes of import-substituting industries. Specialization and trade based on comparative advantage can lead to lower production costs and increased economic output.
Step-by-step explanation:
How do the power of trade and comparative advantage work?
The power of trade and comparative advantage work by raising the average wage rate economy-wide while reducing the incomes of import-substituting industries. Trade based on comparative advantage allows countries to specialize in producing goods and services they can produce more efficiently, which can lead to lower production costs. This specialization and trade can result in increased economic output and improved standards of living.
Example:
For example, let's say Country A can produce 100 units of wheat or 50 units of clothing, while Country B can produce 50 units of wheat or 100 units of clothing. Although Country A can produce both goods, it has a comparative advantage in producing wheat because it can produce more wheat relative to clothing compared to Country B. Therefore, it is more efficient for Country A to specialize in producing wheat and Country B to specialize in producing clothing. By trading with each other, both countries can benefit from the lower production costs and increased output.