4.1 International Trade Flashcards
What is free trade?
Free trade is when trade occurs between countries without restrictions or barriers.
What is absolute advantage?
Absolute advantage refers to the situation where a country can achieve greater production using the same quantity of factors of production as another country. It means that a country with absolute advantage can produce a good or service more cheaply than another country by using its factors of production more efficiently.
What is comparative advantage?
Comparative advantage is the idea that two countries should specialize in goods and services they can produce at a lower opportunity cost compared to another country. By doing so, they can collectively produce more from the same resources, allowing both countries to benefit by consuming beyond their production possibilities curve (PPC). Trade between two countries will only occur if the rate of exchange of goods and services lies between the opportunity cost ratios of production and if money exists as a means of exchange.
How can a country gain a comparative advantage?
A country can gain a comparative advantage due to either greater quantities or better quality factors of production compared to another country. This can include factors such as a greater abundance of natural resources, better quality natural resources, a higher quantity and quality of labor, and more sophisticated capital machinery. A country with a higher skilled labor force is likely to have a comparative advantage in manufactured goods, while a country with a natural resource endowment and favorable climate is likely to have a comparative advantage in primary commodity extraction. Countries with a comparative advantage will specialize and produce more cheaply than countries that do not.
Can comparative advantage change over time?
Comparative advantages can change over time due to factors such as greater research and development, innovation in production techniques, and improvements in education and workforce skills. It is important for countries to not be complacent when they have a comparative advantage and to continually maintain and improve it in order to stay competitive in a highly globalized world economy.
What does the law of comparative advantage suggest regarding trade patterns?
Trade patterns in the world are not concentrated only to the country with a comparative advantage when purchasing goods and services as the law of comparative advantage suggests. Multiple countries can specialize in one area producing the same goods and services for successful export, contradicting the law of comparative advantage.
What implication does the existence of multiple countries specializing in the same area have on the law of comparative advantage?
The existence of multiple countries specializing in the same area contradicts the law of comparative advantage and implies that some assumptions of comparative advantage theory may not fully apply in reality, explaining why countries without a comparative advantage producing at higher cost, charging higher prices, can still survive and be successful.
What assumption does comparative advantage theory make about perfect information?
Comparative advantage theory assumes perfect information for both producers and consumers.
How does the lack of perfect information among consumers affect trade patterns?
However, in reality, many consumers lack information of where the cheapest goods are being produced, which means they may buy from an inefficient producer, allowing these businesses to survive and be profitable.
What assumption does comparative advantage theory make about transport costs?
Transport costs are assumed to be zero according to comparative advantage theory.
What impact can high transport costs have on a country’s comparative advantage?
In the real world, large transport costs may erode a country’s comparative advantage and make it cheaper to import goods from a less efficient producer located closer.
What advantage can countries without comparative advantage have due to expensive research and development spending?
Countries without the comparative advantage may be able to afford expensive research and development spending, allowing for patentable products to be made. This gives such firms the advantage despite not being the most efficient producer.
What assumption does comparative advantage theory make about economies of scale advantages?
Comparative advantage assumes no economies of scale advantages.
How can countries without comparative advantage compete with countries that have a comparative advantage?
In reality, even countries without a comparative advantage can set up large-scale production of a good or service purely to benefit from economies of scale as output increases. This can allow them to compete with countries with a comparative advantage and perhaps over time take over the comparative advantage in production.
What aspect of trade does comparative advantage theory ignore?
Comparative advantage ignores the impact of exchange rate changes.
