Chapter 14 Flashcards
Assumptions of the principle of comparative advantage (CA)
- Only two countries ni the world (e.g. Japan and South Korea)
- Both produce and consume only 2 goods (e.g. air-conditioners and cars)
- Constant opportunity cost is incurred in producing more of either good.
- Transport costs are ignored (production costs does not incur distribution costs)
- Free trade exists between both countries (i.e. no trade restrictions).
- One of the countries is more efficient ni the production of both goods.
Defn. comparative advantage
A country enjoys comparative advantage over another when it can produce a good with a lower opportunity cost in terms of other goods forgone (i.e. the country is relatively more productively efficient than another).
Defn. Principle of CA
The Principle of Comparative Advantage states that trade can benefit all countries, if each country specialises ni the production of goods ni which ti has the lowest opportunity cost or comparative advantage.
Limitations of the principle of CA
- transport costs are ignored
- high transport cost may outweigh or overstate the benefits brought about by the principle of CA. - Specialisation based on CA
- They may not want to be totally dependent in obtaining goods from foreign producers for strategic, political, and economic reasons and hence may not adhere to the principle of comparative advantage. Some examples of these goods would include essentials such as food and water as wel as weapons. For example, countries may strive for fod security, meaning that even if htey do not have a CA in fod production, they still prefer to continue producing food.
sources of CA
differences in opp cost in producing goods between countries are largely the result of differences in quantity and quality of resources in each country
- differences in factor endowment
- Factor endowments would include the amount of land and raw material deposits, climate, population size and demography as wel as capital stock of a country. The different quantities and quality of factor endowment that a country possesses determines its CA.
- phrasing “countries endowed with land, gold, raw materials etc. have CA in producing…” - differences in technological capabilities
- qualities of factors of production
- Countries that are technologically more advanced would usualy have CA ni producing capital intensive goods or services.
Demand &Supply Approach to Indicate CA
- Suppose Japan has a CA in the production of cars. We can indicate this on a demand and supply diagram as seen ni Figure 5.
From Figure 5, Japan is able to produce cars more cheaply than what is available in the world markets (i.e. Japan has a CA in car production). Japan’s domestic price, Pa, is lower than the world price (Pw). With free trade, Japanese car suppliers would rather export their cars and receive the price Pw compared to receiving Pd ni Japan. Hence car prices in Japan wil rise to Pw.
at the world price, the domescit Japanese car producers will be winilig nad abel to supply Qz number of cars, but the domestic consumers wil now only be wiling to consume Q, units. This means that the amount exported would be Q1-Q2 and the export revenue would be Q1ABQ2. - Suppose Japan does not have a CA in the production of air-conditioners, we can indicate this on a demand and supply diagram as seen ni Figure 6.
If Japan is unable to produce air-conditioners (AC) more cheaply than the world markets, it is advantageous for Japan ot import air-conditioners.
Japan is unable to produce air-conditioners more cheaply than what is available ni the world markets (i.e. Japan does not have a CA ni air-conditioner production). Thus, ni Japan, air-conditioner price (Pa) si higher than the world air-conditioner price (Pw). With free trade, consumers in Japan would be wiling ot purchase air- conditioners from the world at Pw rather than pay Pa ni Japan. Hence, for Japanese firms ot sell air-conditioners, they would have to charge Pw i.e. the world price. At the world price, the domestic producers wil be wiling and able ot supply Q, units of air-conditioners, but the domestic consumers wil be wiling ot consume Q units of air-conditioners. This means the quantity of air-conditioners imported into Japan would be Q1-Q2. Import expenditure would be Q1ABQ2.
Defn. dynamic CA
Dynamic comparative advantage refers to shifts ni a country’s opportunity cost that occurs over time.
sources of dynamic CA
Dynamic CA could be attributed to chnages in quanity and quality of FOP:
- changes in the quantity of FOP
- From Figure 7, initially opportunity cost of producing 1additional unit of textiles is to forgo 1 unit of automobile i.e 1T:1A. An increase in the labour force, enables the production of more textiles compared to automobiles and results in the outward pivotal shift of the PPC as shown in Figure 7. The increase in the labour force has resulted ni a fal in the opportunity cost of producing textiles from 1T:1A to 1T: 3⁄4A. The falling opportunity cost of producing textiles has enabled the country to gain CA in textile production. - changes in the quality of FOP
- investments in physical infrastructure
- increased expenditure on training and education
- increased expenditure on technology
-> The improvement of labour productivity would mean that fewer labour wil be required to produce the same amount of the good, or more goods can be produced with the same amount of labour. Assuming that the labour productivity benefits the production of goods ni labour intensive industries more than capital intensive industries, the opportunity cost of producing labour-intensive products such as textiles would fall. This wil result ni a pivotal shift in the PPC curve as shown ni Figure 7. Hence the country may gain CA ni producing labour intensive goods such as textiles. - expanding industries
- Expanding industries offer the prospect of supplying and selling to a larger market which helps to encourage specialisation, division of labour and even higher productivity. The increased efficiency ni such industries would enable them to produce more goods and services with the same amount of labour. An expansion of the textiles industry would lead to a ni a pivotal shift ni the PPC curve as shown ni Figure 7. This would lead ot a lowering ni the opportunity cost of producing textiles.
Singapore’s Factor Endowment and CA :DDD
RESOURCES
1) Well-educated and trained workforce suitable for knowledge-intensive and high-value-added manufacturing
2) Good infrastructure - transports and communication networks, well-planned and well-connected industrial parks; good R&D facilities etc.
3) technological advancement and adoption (eg in automation and robotics, widely used nad accesible info tech etc
EXAMPLES OF PRODUCT EXPORTS
1) biomedical: pharmaceuticals
2) chemical: petrochemicals
3) electronics: water fabrication nad disk-drives
4) marine: oil rigs ans ship-repairing
5) products value-adding: electronic valves and telecommunication equipment (intermediate products) are imported into SG and reprocessed for re-export as value-added product for final assembly in labour intensive countries like China and malaysia
6) high-end services:
- water management (Hyflux SG)
- hospital management
- airport/seaport management ((Eg
Civil Aviation Authority of Singapore, CAAS; and Port of Singapore Authority, PSA)
Resources Singapore Does Not Have:
1) Natural resources - land shortage; lacking ni mineral deposits; unfavourable climate for agricultural activities.
2) Cheap and low-skilled labour - small families and relatively small population size
Examples of Product Imports
1) Fresh Produce: Such as vegetables, poultry, meat, fruits, eggs, etc.
2) Primary Commodities: Such as crude oil, metals (copper, aluminium and steel)
3) Low-end manufactures: Cheap footwear (slippers,
sports shoes) and toys.
Advantages and disadvantages of free trade on households
a) Ability to consume more goods, wider variety of goods at lower prices
b) Increase in Quality of Products
a) higher product prices
b) uncertainty in the quality control of goods
Advantages and disadvantages of free trade on firms
a) ability to reap greater profits via lower costs and rising revenue
- reduced cost
- increases in export revenue
a) increased competition for domestic firm
Advantages and disadvantages of free trade on the economy
a) trade as an engine of growth
b) higher domestic employment
c) lower inflation (cost of living)
a) rising unemployment
- possibility of rising cyclical Un
- possibility of rising structural Un
b) inflation
- cost-push inflation
- dd-pull inflation
c) widening income disparities
d) environmental degradation
Defn. protectionism
refers to the policy of protecting domestic industries against foreign competition by limiting imports or promoting exports via the use of trade barriers
Trade barriers used to engage in protectionism
tariff or non-tariff barriers
- aim of tariff is to increase price of imports and make imports less competitive compared to domestic goods and services
