4.1.2 Specialisation and trade

Question 1

Define theory comparative advantage

Answer 1

If countries specialise in producing the good in which they have a comparative advantage, total output will increase

Question 2

3 assumptions of the theory of comparative advantage

Answer 2

1) Average costs of production are constant
2) No trade barriers
3) No transport costs

Question 3

Limitations of theory of comparative advantage?

Answer 3

1) Specialisation could lead to diseconomies of scale – as firms get bigger - which could lead to less efficiency and thus, higher cost of production - avg costs not constant
2) Trade barriers may eliminate comparative advantage - higher cost reduces demand - so output may reduce instead of increase
3) Transport costs may eliminate comparative advantage as you cannot buy as much due to higher cost from tariff

Question 4

Advantages and disadvantages of specialisation and trade on world output?

Answer 4

+ Comparative advantage states specialisation leads to higher world output – higher real GDP – higher living standards

Based on unrealistic assumptions - hard to apply in reality – therefore GDP and living costs may not increase as much as they should in theory

Question 5

Advantages and disadvantages of specialisation and trade on international markets?

Answer 5

+ May lead to economies of scale - Specialising allows countries to benefit from economies of scale, which reduces costs and decreases prices globally.

• May lead to overdependence on imports and exports

Question 6

Advantages and disadvantages of specialisation and trade on price level

Answer 6

+ Lower prices - economies of scale – lower production costs – lower prices

+ More choice – specialisation leads to international trade to get certain goods – international trade means more choice ALSO

• Diseconomies of scale – increased specialisation increases output – increased output could lead to higher average costs due to diseconomies of scale