More trade theories Flashcards
(30 cards)
What is the difference between absolute and comparative advantage?
Absolute advantage occurs when a country produces a good more efficiently, while comparative advantage is based on opportunity cost—where a country sacrifices less to produce a good.
Absolute advantage- Adam Smith
Comparative advantage- David Ricardo
How does trade increase total output?
Specialization based on comparative advantage leads to more efficient production, increasing the total amount of goods available for consumption.
What are the limitations of the Ricardian model of trade?
- It assumes complete specialization, which is rarely observed.
- It ignores income distribution effects within countries.
- It does not account for resource differences between countries.
What is a Production Possibility Frontier (PPF)?
A PPF shows all possible combinations of goods that a country can produce given its resources and technology.
What is the difference between a linear and non-linear PPF?
- Linear PPF → Constant opportunity costs.
- Non-linear PPF → Increasing opportunity costs as more of a good is produced.
What is utility in economics?
Utility represents the satisfaction or benefit a consumer gets from consuming goods and services.
How do economists measure utility?
By observing consumer choices and ranking consumption bundles from least to most preferred.
What are the key properties of indifference curves?
- Downward sloping (more is better).
- Cannot intersect.
- Each bundle lies on one unique curve.
- Curves are not thick.
How does trade allow countries to consume beyond their PPF?
Specialization and trade increase total world production, allowing countries to import goods they don’t produce efficiently and consume more.
How do we calculate actual gains from trade?
Compare pre-trade production to post-trade consumption and measure the increase in available goods.
What does specialization do to total global output?
It increases total production by focusing on goods with the lowest opportunity cost.
Why does trade benefit both small and large economies?
Trade maximizes efficiency by allowing countries to use their resources where they are most productive.
What is the Heckscher-Ohlin (H-O) theory of trade?
It states that countries will export goods that intensively use their abundant factors of production and import goods that require scarce factors.
What are the key assumptions of the H-O model?
- Two nations, two goods, two factors of production (L, K).
- Countries use the same technology.
- Factor prices differ, influencing production choices.
What is factor intensity in the H-O model?
It refers to whether a good requires more capital (K) or labor (L) to produce.
What is factor abundance?
A country is K-abundant if it has more capital per worker and L-abundant if it has more labor per unit of capital.
How does factor intensity determine trade specialization?
Countries will specialize in producing goods that use their abundant factors more intensively.
What is the factor-price equalization theorem?
The Factor-Price Equalization (FPE) Theorem states that free trade causes the prices of productive factors (like wages and capital returns) to equalize across countries over time.
Why does factor-equalisation occur?
This happens because trade allows countries to specialize in the goods that use their abundant factors more intensively. As a result:
- Wages rise in low-wage countries (where labor is abundant).
- Wages fall in high-wage countries (where labor is scarce).
- Returns on capital (interest rates, profits) rise in capital-poor countries.
- Returns on capital fall in capital-rich countries.
What happens to wages in low-wage countries due to trade?
Wages increase as demand for labor-intensive goods grows.
What happens to wages in high-wage countries due to trade?
Wages decrease as competition from labor-rich countries increases.
How does trade affect the return on capital in rich vs. poor countries?
- In capital-rich nations, returns to capital fall.
- In capital-poor nations, returns to capital rise.
Why does trade not benefit everyone equally within a country?
While total national income rises, some groups (e.g., workers in uncompetitive industries) lose out.
How can trade create income inequality?
High-skilled workers benefit more from trade, while low-skilled workers face wage pressure.
