LS2 - Specialisation & Trade

Question 1

Factor endowment

Answer 1

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

Question 2

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

Reasons for trade

Answer 3

• Resources are unevenly distributed e.g. Saudi Arabia has copious amounts of oil but Switzerland does not. Consequently, countries are not able to produce everything they want.
• Trade provides a mutually beneficial method to obtain goods and services that are unavailable or in insufficient supply in an economy
  Trade due to:
• Different factor endowments
• Price
• Product differentiation

Question 4

What’s specialisation

Answer 4

• when an individual, firm, region, or country concentrates on the production of a limited range of goods and services
• leads to increases in productivity because skill levels and the scale of production rise.
• Improvements in productivity allow firms to increase quality and reduce prices.
  The UK specialises in finance, law, and pharmaceuticals (among other industries).

Question 5

What is the principle of absolute advantage?

Answer 5

• Absolute advantage and comparative advantage are concepts used in theories of international trade.
• The theory of absolute advantage makes some assumptions including:
  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.
• A country is said to have an absolute advantage if it can produce more of a good, using equal amounts of resources, than another country
• can use labour costs instead of output to determine absolute advantage and comparative advantage, the country with the most efficient labour has the absolute advantage.

Question 6

How are trade and specialisation related?

Answer 6

• Trade allows countries to specialise in producing the goods and services they can produce efficiently e.g. UK - services and high value added manufacturers such as aerospace, Bangladesh - labour intensive manufactured goods such as textiles.
• After specialisation, through trade, countries can earn money to import goods and services unavailable in their economy.
  Example: one industry South Korea specialises in is nuclear power. It has exported the construction of nuclear power plants to Jordan and the United Arab Emirates (UAE). This enabled them to afford oil, which it lacks, from oil-producing countries such as the UAE or Iran.

Question 7

What is the theory of comparative advantage?

Answer 7

• 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.
• This theory makes the same assumptions as the principle of absolute advantage.
• calculate by finding opportunity cost using ratios
• country with lower opportunity cost has comparative advantage

Question 8

Principle of comparative advantage holds that countries should:

Answer 8

• specialise in good which they have the lowest (relative) opportunity cost
• trade with the other country to obtain the good they no longer produce
• if so, then expect output to increase over time
• doesn’t say how gains of specialisation will be distributed

Question 9

What’s a trading possibility frontier

Answer 9

• shows exchange rates which allow mutually beneficial trade to take place.
• In the real world countries use exchange rates based on currencies rather than goods.
• However, in the theory of comparative advantage exchange rates are based on the two goods in question

Question 10

Assumptions of the theory of comparative advantage

Answer 10

• There are no transportation costs.
  • There is perfect knowledge, so that all buyers and sellers know where the cheapest goods can be found internationally.
  • The factors of production are perfectly mobile. This means they can be easily switched from producing one good to another (e.g. from bananas to airplanes, from working on a farm to a factory etc.)
  • The cost of producing an extra good is a constant amount of money/resources i.e. the cost of production is constant.
  • There are no external costs in production e.g. no pollution is created by firms or if there is it is internalised.
  • There are no barriers to trade.
  These assumptions are designed to

Question 11

Advantages of specialisation & trade

Answer 11

• Allows countries to focus on goods and services which they have a comparative advantage, leads to improved productivity which results in an efficient (or more efficient) allocation of resources. Furthermore, because specialisation increases productivity output is higher than it would otherwise be without specialisation so GDP rises.
• consumers access a wider range of goods and services, Choice therefore improves through trade. Producers also benefit from improved choice - lowers costs
• Trade opens domestic producers up to competition from abroad. The pressure to maintain competitive prices, high quality, and innovate increases as a result. Consumers should therefore benefit from lower prices and higher quality.
• Trade provides a larger market for firms. This gives them the chance to expand to a size that would be unachievable in one country Increasing size can result in cost advantages for firms (called economies of scale). Trade allows economies of scale to be maximised (or at least increased) and thus costs are reduced. Firms can therefore undercut rivals and provide lower prices to consumers.

Question 12

Disadvantages of specialisation & trade

Answer 12

• Specialisation can lead to an economy or region depending heavily on a small number of industries in some cases, a region may become dependent on a single industry. If an economy or region loses its comparative advantage, it will be outcompeted by rivals in other countries on price and/or quality. Eventually, the industry will decline and likely disappear. Unemployment will rise and GDP will fall as domestic firms close down or scale back their operations.
• Trade and specialisation can leave countries vulnerable to geopolitical change. For example, many Western countries rely on Arab states for their oil supply. When Oil prices rise, Inflation and panic ensue Similarly, around 50% of the food produced in the UK is imported. 30% of the is from the EU A less import dependent food strategy would have reduced this risk.
• If a country loses an industry due to a loss of comparative advantage, structural unemployment is likely to follow (without government intervention). For example, when coal mining declined, the newly unemployed lacked the skills to work in other industries because they had specialised in coal mining. However, some were too old to retrain or unwilling to uproot for employment in another part of the country. Many of these workers were unemployed for a long time. Some dropped out of the labour force altogether. This shows a danger of specialisation.
• For developing countries, strict adherence to the principle of comparative advantage may be a poor long term development strategy. Developing countries tend to have comparative advantages in primary products. Specialisation in this area is likely to result in weak economic growth because value added is usually low. In contrast, manufacturing and services tend to have higher long-term profitability than primary products. If a developing country specialises in primary products, this may limit the country’s ability to diversify is economy and develop into more wealth creating industries.