3.1 Trade (+Comparative Advantage)

Question 1

Why do countries trade

Answer 1

• Increase variety and choice
• import inputs for production
• more efficient allocation of resources
• to take advantage of economies of scale
• lower prices
• technology transfer
• source of foreign exchange
• access to larger markets
• more efficient production

Question 2

absolute advantage

Answer 2

a country has absolute advantage in the production of a good when it can produce a good using fewer resources than another country

Question 3

Comparative Advantage

Answer 3

a country has comparative advantage in the production of a good when it can produce a good at a lower opportunity cost than another country.
Basically, a country has to give up fewer units of other goods to produce a good in comparison to what another country has to give up.

Question 4

diagram for comparative advantage

Answer 4

the better producer’s comparative advantage is where the distance between the ppcs is the greatest.
the less efficient producers comparative advantage is where the distance of the ppcs is the smallest.
trade should only take place if the opportunity costs are different. if they are the same, there is no gain from trading.

Question 5

limitations of the comparative advantage theory

Answer 5

• assumes perfect knowledge
• assumes no transport costs
• assumes only two economies and two goods
• assumes costs do not change and returns to scale are constant
• assumes the goods traded are identical
• assumes FOP remains in country and that all stages of production take place in the same place
• assumes free trade