Specialisation & Trade

Question 1

Define absolute advantage

Answer 1

Absolute advantage- country can produce ⬆️ of a product than another country

Question 2

Define comparative advantage

Answer 2

Comparative advantage- country can produce product at lower ⬇️ opportunity cost than another country … relative advantage in production

Question 3

What if a country has an absolute advantage in the production of all 🚘?

Answer 3

The country can still benefit from specialisation and trade if ONLY it specialises in production of 🚘 in which it as a comparative advantage

Question 4

What are the assumptions in the theory of comparative advantage?

Answer 4

1) ✖️ transport costs
2) ✖️ trade barriers
3) average cost of production is constant
4) buyers/consumer have perfect knowledge
5) Perfect mobility of resources between different uses

Question 5

Describe a numerical example to illustrate comparative advantage

Answer 5

• 2 countries- country A and country B
• country A produces 20,000 palm oil and 10,000 T.Vs
• country B produces 8,000 palm oil and 8,000 T.Vs
• working out the opportunity cost shows that country A has CA in producing palm oil whilst country B has CA in producing T.Vs

Question 6

What if the opportunity costs are the same?

Answer 6

Then there is ✖️ benefit from specialisation and trade

Question 7

What must happen for the trade to be beneficial?

Answer 7

The terms of trade must lie between the opportunity cost ratios

Question 8

How do you calculate the terms of trade?

Answer 8

(index of export prices/index of import prices) x 100

Question 9

What are limitations of the principle of comparative advantage?

Answer 9

1) Transport ✈️ 🚛 costs might outweigh benefits of comparative advantage
2) Trade barriers might distort comparative advantage
3) ⬆️ specialisation and production might-> diseconomies of scale … ⬆️ average cost

Question 10

What are the advantages of specialisation and trade?

Answer 10

1) Efficient resource allocation- specialisation and free trade based on comparative advantage … resources allocated efficiently and … production efficient
2) ⬆️ world output-> ⬆️ living standards
3) ⬇️ prices and ⬆️ choice for consumers
4) Incentivises domestic producers to become ⬆️ efficient as foreign firms ⬆️ efficient
5) Larger markets-> ⬆️ production and ⬇️ costs (efficiency)… economies of scale as costs distributed across ⬆️ 🚘

Question 11

What are the disadvantages of specialisation and trade?

Answer 11

1) Law of comparative advantage based on unrealistic assumptions
2) Developing economies might only specialise in production of primary products … prevents diversification into ⬆️ productive manufacturing industry
3) Over-dependence on imports- e.g. raw materials- strategic importance- crucial for production … halts production- 👎 impacts
4) If country’s 🚘 and 🧹 uncompetitive-> persistent trade deficit