Unit 4: Specialisation and Trade

Question 1

What is Comparative Advantage?

Answer 1

A country has a comparative advantage over another in the production of a good if it can produce it at a lower opportunity cost.

Question 2

What is Absolute Advantage?

Answer 2

A country has absolute advantage if it can produce more of multiple goods with the given resources.

Question 3

What are the Assumptions made in Comparative Advantage theory?

Answer 3

1. There are only two countries producing two goods.
2. There are no transport costs.
3. Traded goods are identical.
4. There are no tariffs or trade barriers.
5. Buyers and sellers have perfect knowledge of prices.
6. Static theory – consider changing prices over time, has it been beneficial?

Question 4

What do Parallel lines on a comparative advantage graph show?

Answer 4

Parallel lines on a PPF show that opportunity cost is the same in both countries. Therefore there can be no gains from trade.

Question 5

How do you Calculate Comparative Advantage of a product in Tabular form?

Answer 5

Using the same country, divide the other product by the first product.

The country with the lowest number of that product has the lowest opp. cost; meaning is has the CA.

Question 6

How do you Calculate Comparative Advantage of a product in Diagram form?

Answer 6

The steeper curve represents the country which has CA on the y axis.

The opposite applies to the x axis (unless they’re parallel)

Question 7

What are the Limitations to the Comparative Advantage Theory?

Answer 7

1. CA doesn’t consider the exchange rate
2. Countries are able to develop a CA of a good (e.g. Vietnam in the production of coffee- over 30 yrs their market share went from 1% to 20%)
3. It can be argued that CA is no longer a relevant concept: Within countries, a wide variety of goods + services are produced, and there is very little specialisation. This is helped by the advancement of technology

Question 8

What are the Advantages of Specialisation + Trade in an International Concept?

Answer 8

o Greater world output, so there is a gain in economic welfare.

o There could potentially be higher quality, since production focuses on what
people and businesses are best at.

o A greater variety of goods and services could be produced.

o Lower average costs, since the market becomes more competitive.

o There is an increased supply of goods to choose from.

o There is an outward shift in the PPF curve.

o More opportunities for economies of scale

Question 9

What are the Disadvantages of Specialisation + Trade in an International Concept?

Answer 9

o Less developed countries might use up their non-renewable resources too quickly, so they might run out.

o Countries could become over-dependent on the export of one commodity, such as wheat. If there are poor weather conditions, or the price falls, then the economy would suffer.

o There could be more structural unemployment, since production moves abroad.

o Some countries might become stuck in the production of one good or service, so they cannot develop further.