Trade Theory

Question 1

What are the assumptions made in trade theory

Answer 1

Two countries produce two goods
Each country devotes half its resources to the production of each good
Transport costs are negligible
There are constant returns to scale
Factors of production are mobile within the countries

Question 2

Define comparative advantage

Answer 2

Occurs when a. Country can produce a good or service at a lower opportunity cost

Question 3

Define absolute advantage

Answer 3

When a country can produce a particular good more efficiently than another country

Question 4

What are the limitations of the trade theory

Answer 4

Transport costs —> can eliminate comparative cost advantage
EoS/DoS —> constant costs are unlike;y
Homogenous goods —> goods are differentiated (may be inferior)
FoP immobility —> labour is not always mobile (occupational immobility)
Tariffs —> push up the price eliminating cost advantages
Currency exchange —> change cost advantages

Question 5

Define international competitiveness

Answer 5

Ability to sell goods and services at competitive price in a foreign country

Question 6

What is the formula for the terms of trade index

Answer 6

Index of export prices/index of import price

X 100

Question 7

What is a favourable movement in the terms of trade

Answer 7

Export prices rise relative to price of imports

For a given quantity of exports the country can buy imports

Question 8

What is an unfavourable movement in the terms of trade

Answer 8

Export prices falling relative to price of imports

For a given quantity of exports the country can buy fewer imports

Question 9

What affects the price of imports and exports

Answer 9

Exchange rate changes
Inflation
Change in demand/supply
Protectionism
Interest rate (hot money flows)
EoS/DoS