LS2 : specialisation and trade

Question 1

what is factor endowment?

Answer 1

the amount of land, labour, capital and entrepreneurship that a country possesses and can exploit for production

Question 2

what is product differentiation?

Answer 2

the process of distinguishing a product or service from others, to make it more attractive to a target market

Question 3

what are three main reasons that countries trade with one another?

Answer 3

1. different factor endowments
2. price
3. product differentiation

Question 4

what is specialisation?

Answer 4

when an individual, firm, region or country concentrates on the production of a limited range of goods and services. this leads to increases in productivity.

Question 5

how are trade and specialisation linked?

Answer 5

trade allows countries to specialise in producing the goods and services they can produce efficiently. through trade, countries can earn money to import goods and services unavailable in their economy.

Question 6

what are two assumptions that the absolute advantage theory makes?

Answer 6

1. there are two countries in the world who each have an equal amount of resources
2. both countries are capable of producing two goods

Question 7

how does a country have absolute advantage?

Answer 7

if it is able to produce more of a good, using equal amounts of resources than another country

Question 8

what is the principle of comparative advantage?

Answer 8

the theory of comparative advantage holds that specialisation and trade can be mutually beneficial even if one country has an absolute advantage in producing both goods.

Question 9

how do we calculate opportunity cost?

Answer 9

using ratios

Question 10

what is the principle of comparative advantage?

Answer 10

• specialise in the good which they have the lowest (relative) opportunity cost
• trade with other countries to obtain the good they no longer produce

Question 11

what is autarky?

Answer 11

economic independence or self-sufficiency

Question 12

what is a trading possibility frontier?

Answer 12

shows exchange rates between goods which allow mutually beneficial trade to take place

Question 13

what are the assumptions of the theory of comparative advantage?

Answer 13

• no transportation costs
• perfect knowledge, buyers and sellers know where the cheapest goods can be found internationally
• FoP are perfectly mobile, production can be easily switched to another product
• cost of production is constant for each additional unit
• no external costs in production
• no barriers to trade