Law of Comparative advantage Flashcards
(20 cards)
What is Absolute Advantage in international trade?
Absolute advantage occurs when a country can produce more of a good using fewer resources (factors of production) than another country.
What is Comparative Advantage?
Comparative advantage is when a country can produce a good at a lower opportunity cost than another country. It should specialise in that good and trade with others for efficiency.
State the Law of Comparative Advantage.
Countries should specialise in producing goods in which they have a comparative advantage (lower opportunity cost) and then trade, leading to a more efficient allocation of resources globally.
What assumptions does the Law of Comparative Advantage make?
No transport costs
Constant returns to scale
No trade barriers
Perfect mobility of resources within countries
Two countries and two goods
Country Cotton (tonnes) Computers (units)
India 20 10
Ghana 16 2
Who has the absolute advantage in both goods?
India, because it can produce more of both cotton and computers than Ghana using the same resources.
What is Ghana’s opportunity cost of producing 1 computer?
Ghana gives up 8 tonnes of cotton for each computer (16 ÷ 2 = 8).
What is India’s opportunity cost of producing 1 computer?
India gives up 2 tonnes of cotton for each computer (20 ÷ 10 = 2).
Which country has the comparative advantage in computers?
India, because its opportunity cost (2 tonnes of cotton per computer) is lower than Ghana’s (8 tonnes per computer).
Which country has the comparative advantage in cotton?
Ghana, because its opportunity cost (0.125 computers per tonne of cotton) is lower than India’s (0.5 computers per tonne).
According to the law, what should each country specialise in?
India should specialise in computers
Ghana should specialise in cotton
They should trade to benefit from specialisation.
What is a Production Possibility Curve (PPC)?
A PPC shows the maximum possible output combinations of two goods that an economy can produce using all its resources efficiently.
Given this production data, what are India’s and Ghana’s PPCs?
Country Cotton (max tonnes) Computers (max units)
India 20 10
Ghana 16 2
So the endpoints of the PPCs are:
India’s PPC: from (20 cotton, 0 computers) to (0 cotton, 10 computers)
Ghana’s PPC: from (16 cotton, 0 computers) to (0 cotton, 2 computers)
What is the opportunity cost for India to produce 1 computer?
India gives up 2 tonnes of cotton for each computer (20 ÷ 10 = 2).
What is the opportunity cost for Ghana to produce 1 computer?
Ghana gives up 8 tonnes of cotton per computer (16 ÷ 2 = 8).
What is the opportunity cost for India to produce 1 tonne of cotton?
0.5 computers (10 ÷ 20 = 0.5).
What is the opportunity cost for Ghana to produce 1 tonne of cotton?
0.125 computers (2 ÷ 16 = 0.125).
Who has the comparative advantage in computers?
India, because it has the lower opportunity cost (2 cotton per computer vs Ghana’s 8 cotton per computer).
Who has the comparative advantage in cotton?
Ghana, because it has the lower opportunity cost (0.125 computers per tonne of cotton vs India’s 0.5 computers per tonne of cotton).
How does the PPC help illustrate comparative advantage?
The PPC shows the trade-offs between two goods. The slope (or gradient) of the PPC reflects the opportunity cost. A flatter PPC means lower opportunity cost for the good on the horizontal axis.
What should happen according to comparative advantage theory?
India should specialise in computers
Ghana should specialise in cotton
They should trade with each other for mutual benefit
