Law of comparitive advantage 4.1.2

Question 1

Define absolute advantage?

Answer 1

This occurs when a country can produce a product using fewer factors of production than another nation.

Question 2

Define comparative advantage?

Answer 2

This states that a country should specialize in the goods and services it can produce at the lowest opp cost, and then trade with another country.

Question 3

Explain the concept of comparative advantage?

Answer 3

Two countries in the world are producing two goods and services

• assume India is producing computers
• assume Ghana is is producing cotton
• using the law of absolute advantage it is clear to see that India have the absolute advantage in producing both cotton and computers.
• you can see this from the table production: India 20 cottons or 10 computers and Ghana producing 10 cotton or 2 computers.

Question 4

How would the diagram look like for this example?

Answer 4

• label the x-axis as cotton
• label y-axis as computer
• draw the two lines across
• a trick you can use is by seeing the biggest gap on the axis so whoever is producing more on will have the comparative advantage
• India has the advantage on y-axis
• Ghana has the advantage on x-axis

Question 5

How do you work out the opportunity cost from the table?

Answer 5

Lets assume that India wants to produce one tonne of cotton, how many computers are they giving up to do that?

• Divide both sides by 20 to get 1 cotton
• orginally producing 10 comps so divide by 2 to get 1/2
• for Ghana to produce 1 tonne of cotton
• 16 divide by 16 to get 1 cotton
• 2 divide by 16 to get 1/8 comptuer
• vice-versa to produce one comp

Question 6

What will David Ricardo state now?

Answer 6

David will step in and state whoever has the lowest OC will wins- since they should then specialize in producing that good and trade freely with another country.

• Ghana has the comparative advantage in producing cotton because they are only giving up 1/8th of producing the computer whereas India are giving up 1/2 of comps.
• India has the comparative advantage in producing computers

Question 7

But for trading to be mutually beneficial what has to happen?

Answer 7

Each country to exploit their comparative advantage- there needs to be a suitable rate of exchange

Question 8

How is this rate of exchange explained in the graph?

Answer 8

It has to lie between the opp. cost ratio of production for the two given countries

• so if India is producing 2 cottons and Ghana is producing 8 cottons
• the rate of exchange will state that it will be 5
• Now if the rate is closet to India it will be beneficial to Ghana and vice-versa.
• If India gets less than 2 cotton then what is the point of selling it to Ghana they at least need to 2 tonnes of cotton for trading to be effective
• if Ghana pays for 8 tonnes of cotton or less, if they pay more than this for each computer then what is the point?

Question 9

How does specialization link in this topic?

Answer 9

• Since Ghana is specializing in cotton could because they have a abundance of cotton plants
• India the quantity of their labor force lends themselves very well to produce computers.