2- Specialisation and Trade

Question 1

Absolute advantage definition

Answer 1

Implies that a country can produce more of one product than another can with the same amount of resources.

Question 2

Comparative advantage definition

Answer 2

If a country has a comparative advantage it can produce a good with a lower opportunity cost than that of another.

Question 3

David Ricardo link between specialisation and trade

Answer 3

• David Ricardo demonstrated that trade between the two nations can be beneficial for both if each specialises in the production of a good in which it has a comparative advantage (even if one has an absolute advantage in one).

Question 4

Assumptions of the law of comparative advantage

Answer 4

• Constant returns to scale- this would imply the PPF is drawn as straight line
• No transport costs
• No trade barriers
• Perfect mobility of factors of production between different uses
• Externalities are ignored
• International trade depends upon exchange rates, which are not factored in.
• Opportunity cost ratios remain unchanged which given on going changes to efficiency improvements in different industries

Question 5

Limitations of law of comparative advantage

Answer 5

• Free trade is not necessarily fair trade (e.g. the rich countries might exert their monopsony power to force producers in developing countries to accept very low prices).
• It is based on unrealistic assumptions such as constant costs of production, zero transport costs and no barriers to trade.
• If opportunity costs were the same, then there would be no benefit from specialisation and trade.

Question 6

Advantages of specialisation and trade

Answer 6

• Higher living standards and increased employment resulting from an increase in world output.
• Lower prices, increased choice
• Transfer of management expertise and technology transfer
• Economies of scale
• Reduction in power of domestic monopolies

Question 7

Disadvantages of specialisation and trade

Answer 7

• A deficit on the trade in goods and services balance if a country’s goods and services are uncompetitive.
• Danger of dumping- firms in countries with surpluses of goods and services might ‘dump’ them on other countries. This could cause local producers to go bankrupt. In the long run the country could become dependent on imports
• Increased unemployment
• Increased risk and contagion
• Unbalanced development - only industries where the country has a comparative advantage will develop
• Sectoral imbalance- limit eco growth
• ## TNC’s may become global monopolies

Question 8

Problems developing countries could face due to specialisation and trade?

Answer 8

• Infant industries may be unable to compete and go out of business
• Monopsony power of firms in developed countries may force producers in developing countries to accept low prices for their products
• Declining terms of trade dependant on primary products

Question 9

International trade definition

Answer 9

The exchange between different economic agents in different countries.

Question 10

Import definition

Answer 10

A good or service bought in one country that was produced in another.

Question 11

Export definition

Answer 11

Goods and services that are produced in one country and sold to buyer in another.

Question 12

Monopsony definition

Answer 12

Refers to a sole buyer of a product or service.

Question 13

Dumping definition

Answer 13

Occurs when a product is sold to a foreign country for less than the cost of making the product
Illegal under rules of WTO

Question 14

Sectoral imbalance definition

Answer 14

Refers to an imbalance in the three main sectors of the economy - primary, secondary and tertiary sectors.