4.1.2 - Specialisation and trade

Question 1

Application - Comparative advantage

Answer 1

Question 2

Application - Changes in relative exchange rates

Answer 2

Question 3

Define the term comparative advantage.

Answer 3

• When a country can produce a good with a lower opportunity cost.

Question 4

If two countries are given to you how would you work out which one has the comparative advantage ?

Answer 4

• You would calculate the opportunity cost fr producing that good.
• The country with the lowest opportunity cost for Producing that good has the comparative advantage (Ratio 1: lower number)

Question 5

Using A diagram explain comparative and absolute advantage.

Answer 5

• Country A has an absolute advantage.
• Country B has a comparative advantage in the production of smart phones.
• Whereas country A has the comparative advantage in the production of maize.

Question 6

What is the theory of comparative advantage ?

Answer 6

• that if countries specialise in producing goods where they have a lower opportunity cost – then there will be an increase in economic welfare.

Question 7

What does the theory of comparative assume ?

Answer 7

1. Average cost of production is constant.
2. No trade barriers
3. No transport cost
4. External costs of production are ignored

Question 8

What is the limitation of the first assumption of the theory of comparative advantage.

Answer 8

• Average cost of production is may not be constant.
• This is due to diseconomies of scale (increase in output lead to increase long run average costs).

Question 9

What is the limitation of the second assumption of the theory of comparative advantage.

Answer 9

• Trade do barriers exits. (E.g tariffs, embargo’s, quotas)
• Trade barriers may distort comparative advantage. As it increases the price of imports.

Question 10

What is the limitation of the third assumption of the theory of comparative advantage.

Answer 10

• There are transport costs.
• This will also increase the price of importing goods from countries who have specialised due to comparative advantage.

Question 11

What is the limitation of the fourth assumption of the theory of comparative advantage.

Answer 11

Question 12

In terms of power and fairness what is another limitation to the law of comparative advantage ?

Answer 12

Free trade is not necessarily fair trade (i.e. the rich countries might exert their monopsony power to force producers in developing countries to
accept very low prices).

Question 13

Advantage of specialisation of trade

Answer 13

Question 14

Disadvantage of specialisation of trade

Answer 14

Question 15

In terms of external shock what are some real life application ?

Answer 15