2 Specialisation and Trade

Question 1

What happened to GDP per capita over the last centuries?

Answer 1

“Hockey-stick” of history: rapid and sustained growth in average living standards since 1700.

Britain was the first country to experience this (1650) then Japan in 1870, China and India in the second half of the 20th c.

Question 2

Effects of 🌟 THE CAPITALIST REVOLUTION 🌟

Answer 2

Led to growth in living standards because of:

• impact on technology: firms competing in markets had strong incentives to adopt and develop new technologies
• specialisation: the growth of firms and the expansion of markets linking the entire world allowed historically unprecedented specialisation in tasks and production.

Question 3

Define absolute advantage

Answer 3

The ability of an agent (individual/firm/country) to produce a greater quantity of something than competitors, using the same amount of resources.

Question 4

Define comparative advantage

Answer 4

The ability of an agent to produce a good more efficiently than competitors.

Question 5

Define terms of trade

Answer 5

Amount of one good traded for another, or ‘relative price’.

Question 6

What did Ricardo show?

Answer 6

Despite one country may have absolute advantage in both goods, they can still benefit from trade by specialising in producing what the have comparative advantage in.

Question 7

How can we show comparative advantage?

Answer 7

• Identifying relative production costs across countries (monetary or resource costs)
• Compare the opportunity costs of producing goods (or their relative prices) across countries.

Question 8

Define Production Possibility Set

Answer 8

The set of combinations of outputs which can feasibly be produced by devoting various combinations of resources to their production.

Question 9

What do production possibility sets do?

Answer 9

Embody the feasible alternatives.

Crystallise opportunity costs in terms of the production trade-off.

Question 10

Define Production Possibility Frontier

Answer 10

The boundary of the production possibility set.

A point where the economy is technically efficient.

Question 11

What is the MRT?

Answer 11

Marginal Rate of Transformation- rate of exchange between producing two goods.

Question 12

How is the MRT reflected in the PPF?

Answer 12

As the slope of of the PPF at the given point (i.e. slope of that tangent).

It is the opportunity cost.

Question 13

How does the MRT change? Implications?

Answer 13

PPF’s often concave toward the origin → MRT gets steeper.

This shows diminishing marginal returns.

Question 14

Define autarky

Answer 14

Economic independence or self-sufficiency.

Question 15

When do gains from trade arise?

Answer 15

Whenever there is heterogeneity in production opportunity costs.

Question 16

Where do comparative advantages arise from?

Answer 16

They arise due to the distribution across countries, of the things you use to make stuff with (factors of production).

Question 17

Fixed and mobile factors of production

Answer 17

• Natural resources like weather, and land are fixed.
• Financial capital is generally considered a highly mobile factor.
• Labour is intermediate - it is generally considered a fixed factor in countries which do not allow immigration; in other countries, and especially in some industries, labour is highly mobile.

Question 18

What is Ricardian theory good at explaining? (3)

Answer 18

• It suggests that countries with the right weather and large land mass should export agricultural goods.
• It suggests that complex technical goods should be created in developed nations with highly educated workforces.
• It suggests that natural resources should be exported by less developed nations.

Question 19

What does Ricardian theory fail at explaining?

Answer 19

It suggests that there should be more trade between developed and underdeveloped nations than between developed and other developed nations (inter-industry trade).

This in not the case – the vast majority of trade is between developed nations (intra-industry trade).

Heterogenity only provides incentives to trade.