4.1.2 Specialisation and trade

Question 1

How do you use graphs to model international trade?

Answer 1

Two graphs
Net exporter:
- Draw a domestic supply and demand diagram
- The world price line is at the the top of the diagram
- The QD line goes down from where PW meets the demand curve
- The QS line goes down from where PW meets supply
- The area between QD and QS is exports
- There is excess supply as supply>demand.
Net importer:
- Draw a domestic supply and demand diagram
- The world price line is at the bottom of the diagram
- The QD line goes down from where PW meets the demand curve
- The QS line goes down from where PW meets the supply curve
- There is excess demand as demand>supply

Question 2

Absolute advantage

Answer 2

When a country can produce more of one product than another country.

Question 3

Comparative advantage

Answer 3

When a country can produce at a lower opportunity cost than another country.

Question 4

Law of comparative advantage

Answer 4

Even if a country has an absolute advantage in the production of all goods, it can still benefit from specialisation and trade if it specialises in the production of goods in which it has a comparative advantage.

Question 5

What are the five assumptions of the theory of comparative advantage? (PaCT)

Answer 5

• Perfect mobility of resources between different users
• Perfect knowledge
• Constant costs, no economies of cale
• No transport costs
• No trade barriers

Question 6

What is a limitation of using the theory of comparative advantage?

Answer 6

It is highly unrealistic as not all labour can do the same for both products.

Question 7

What are five advantages of specialisation and trade?

Answer 7

• Specialisation and free trade based on comparative advantage means efficient resource allocation.
• Higher world output and living standards.
• Consumers have lower prices and more choice.
• Incentive for producers to be more efficient.
• Larger markets for firms so will benefit from economies of scale.

Question 8

What are five disadvantages of specialisation and trade?

Answer 8

• Law of comparative advantage is based on unrealistic assumptions.
• Specialisation in primary products prevent diversification into more productive manufacturers.
• Risk of over dependence on imports (china).
• What you specialise in may become uncompetitive over time, leading to structural unemployment.
• Negative externalities.