Free Trade

Question 1

What is free trade?

Answer 1

This is where there are no restrictions on trade between countries, e.g. no tariffs.

Question 2

What is the theory of competitive advantage? *

Answer 2

The theory of competitive advantage provides the theoretical basis of the benefits countries will get from free trade.

The theory states that if all countries specialise in producing these products that they can produce best, i.e. what their own resources are best suited to produce, then the output produced by all countries would be maximised, therefore all countries will be better off.

Question 3

What are the two main reasons a country may have an advantage in producing certain products?

Answer 3

1) A natural/geographical advantage in producing certain products - e.g. weather - Brazil may have a natural advantage in producing coffee, The Caribbean and tropical fruits. China in manufacturing goods (Due to the abundant sources of labour)
2) An acquired advantage in producing certain products i.e. Skills and expertise that they have built up over a long period of time, giving then an advantage. E.g. in the UK its financial services, for the US it’s IT and software, for Germany its high quality engineering products.

These factors often go together, for example French wine.

Question 4

What are the assumptions for the theory of competitive advantage? (7)

Answer 4

1 - We assume there are only two countries in the world
2 - They only produce two products
3 - Initially there’s no specialisation
4 - We assume that there are constant returns to scale
5 - The theory assumes there is perfect mobility of resources between industries in a country
6 - We assume there are no transport costs
7 - There are no restrictions between trade

Question 5

Refer to your notes and remind your self how to present the theory of competitive advantage!

Answer 5

Well done :)

Question 6

What are the 5 criticisms of the theory of comparative advantage?

Answer 6

1 - The theory assumes that there are no transport costs in trade. However, in practice there will always be some extra transport costs involved in trade between countries which tend to reduce the benefits.

2 - The theory assumes that the people within a country are equally skilled at producing all goods

3 - The theory assumes all resources are perfectly mobile between the different industries

4 - Although the theory suggests all countries will benefit from trade, they may not benefit equally

5 - There’s a danger that countries could become too specialised in producing certain products, and overdependent. Particularly food - e.g. bad weather can have a huge impact on that economy.

However, despite the criticisms, most economists would accept we would be much better off with free trade.