To explain why countries trade, we must look at a little economic theory. The first concept we'll consider is called the theory of absolute advantage. If a country has the absolute advantage in the production of a good or service, it means it's the most efficient producer of that product. In other words, if all countries use the same inputs in their production process, this country would be able to make more better quality products than all the others. Let's construct a simplified theoretical example to illustrate the point. Imagine for a moment the we live in a world where there are only two countries, South Africa and Japan. Now both countries have differing capabilities to produce two products, wheat and DVDs. Now, over a certain time period, South Africa can either produce 55 bags of wheat or 11 DVDs using all their resources. Japan, on the other hand, can either produce 18 bags of wheat or 72 DVDs using all the available inputs that they have. So, knowing that each country must choose how to allocate its resources between the production of these two goods, does it make sense for South Africa to produce any DVDs? The answer is no. Japan is obviously much more efficient in the production of DVDs than South Africa, while South Africa is much more efficient in the production of wheat than Japan. But both countries need both products, so it makes sense for South Africa to provide Japan with South African grown wheat in exchange for DVDs made in Japan. If each country concentrates on producing what it's naturally good at, if they specialize in that good, both countries can then trade with each other and end up with more of both products than if they try to produce it all themselves. The consumers in both countries also benefit because they will be buying products made by the most efficient producer. And according to the economic theory, it means that the price paid for these products should be the cheapest. Why? Well, because the producers making the two products are the most efficient at it and can make more of the product for less than their competitors. Remember that as a consumer, you will not buy the same product from a seller who's more expensive. So, the economic principle of absolute advantage is that you should specialize in the production of something that you're good at making. You will be efficient in the production of that good or service and the price you sell at will be the most competitive. Now, why is this considered so important in economics? Well, remember, economics is all about satisfying unlimited wants and needs. How can we get all of the things we want with such limited resources? Resources we really can't afford to waste through inefficient production? Okay, let's try and take the theory a bit further. According to this new table, we assume that South Africa has an absolute advantage with both products. It can efficiently produce either wheat or DVDs. Looking at this new data, it would seem that there is no longer any reason for trade between these two countries. But this is not quite true. Let's see why. Remember that each country must decide how to allocate its resources. In a simplified example, we'll say that if South Africa concentrates all of its resources on DVD production, it can make 8 DVDs. But this means losing out on the wheat. And if they focus all their efforts on wheat production, they can produce 40 bags while sacrificing any DVD production. The best way to help South Africa decide how to allocate resources is to calculate how much it costs to make one DVD. Comparatively, how much wheat the South Africa have to give up to make one DVD? It's not too tricky. Divide 40 by 8, which gives us 5. So, for each DVD we produce, we could have grown 5 bags of wheat. In other words, each DVD we make costs South Africa 5 bags of wheat. Now, over in Japan, if they choose to produce 4 DVDs, they can't produce any wheat because of their limited resources. And if they focus on just producing the 8 bags of wheat, there's nothing left for DVD production. Doing the maths, 8 divided by 4, we can see that it will cost Japan 2 bags of wheat to make 1 DVD. So, comparing the cost of production in both countries, South Africa has to give up 5 bags of wheat for each DVD it makes. While in Japan, it only costs 2 bags of wheat to make 1 DVD. So, DVDs cost more in terms of bags of wheat given up in South Africa than they do in Japan. Or in less clumsy language, it's cheaper for Japan to make DVDs. So, Japan should make the DVDs. And it also makes sense that South Africa should produce the wheat. And that's the theory of comparative advantage. Remember, don't let the numbers confuse you. They're just used to help us understand the theory. If you need to,