4.1 Theories of Trade

Question 1

What does the Theory of “Absolute Advantage” state?

Answer 1

This theory states that a country should specialize in producing the goods and services in which they are the more efficient than other countries/producers. This should increase their production of specialized goods and services. Which they should trade with other countries/ producers. This allows them to consume beyond their PPC.

Question 2

What is the “Autarky”?

Answer 2

Domestic production and consumption, no specialization and no trade.

Question 3

What are some benefits from free trade?

Answer 3

• increased competition
• lower prices
• greater choice
• acquisition of resources
• more foreign exchange earnings
• access to larger markets
• economies of scale
• more efficient resource allocation
• more efficient production

Question 4

What does the Theory of “Comparative Advantage” state?

Answer 4

A country should produce and specialize in the product in which they have the lowest opportunity cost

Question 5

What is the difference between Absolute and Comparative advantage?

Answer 5

Absolute:
A country which produces MORE of a good or service using ALL its resources compared to another country - should specialize in producing that g/s

Whereas, Comparative:
A country which has a lower OPPORTUNITY COST in producing a good or a service should specialize in production of that g/s

Question 6

What are some of the sources of comparative advantage?

Answer 6

1) Land
–> natural resources
2) Labour
–> skills and wage costs of labour force
–> quality of labour force
3) Capital
–> availability and quality of the machinery
4) Enterprise
–> research and development
++++ Other factors +++++
–> eg. exchange rate
–> corruption