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Can different endowments of factor resources fully explain countries differences in comparative costs.

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Introduction

Can different endowments of factor resources fully explain countries differences in comparative costs. Just as firms specialise in producing different types of goods so to do countries. This allows them to benefit from their location, capital equipment and others assets they own. Countries intend to produce more of certain goods than is needed for domestic consumption in order for these goods to be exported. A large majority of capital gained from exporting is then used in order to buy imports. These are usually products which the country cannot produce domestically or that it produces very little of. A country must identify which products it should export and which it should import as many countries have the ability to produce similar products. The law of comparative cost advantage can be used in order to solve this problem. This law was a theory of Economist David Ricardo who adopted Smiths idea of a division of labour and specialisation of trade between countries. A country's labour skills, raw materials, capital equipment, population density and climate are all examples of its factor resources. All countries have similar resources but in different quantities. These tend to remain constant as the land and climate of a country cannot be changed. ...read more.

Middle

Therefore the pre-trade exchange ratio for the less developed country would be two wheat for one silk and the developed country one wheat for two silk. As long as the exchange ratio is between 2:1 and 1:2 both countries will gain from exporting. The less developed country will gain from exporting wheat and importing silk and the opposite will be the case for the developed country. The relative price of wheat and silk after trade takes place will determine the actual exchange ratio. Prices are determined by total demand for and total supply of the good. Gains of the two countries may not be equal if the trade exchange ratio is nearer to one of the countries pre-trade ratios. If a country increasingly specialises in one particular good, eventually it will cut into resources that would more adequately produce other goods. Therefore quantity produced of the other goods will be decreased. As a result, the country's opportunity cost will increase. For example if a country specialises increasingly more in the production of tomatoes, it will have to cut into land that was used to grow potatoes. This land is less suited for tomato production and it also means land is taken away from and therefore a reduction in production of potatoes. ...read more.

Conclusion

These will be determined by the elasticity of demand for imports. If demand is elastic then the price increase imposed by the tariff will lead to a fall in demand for the import thus protecting domestic industries. Quotas are a quantity restriction on the amount of imports allowed into a country. They protect inefficient home producers. As a result people employed within certain declining industries may benefit, but consumers are left to pay higher prices for the goods. Comparative advantage also assumes there is perfect knowledge within markets. All buyers and sellers know where the cheapest goods can be found internationally. In conclusion countries have different endowments of factors of production. These differences include population density, labour skills, capital employment, climate and raw materials. Country's different factors remain somewhat unique as they are relatively immobile between countries. Land and climate are obviously immobile but restrictions, such as physical and social ones, restrict countries in the international market more than in their domestic market. Comparative costs of producing goods therefore vary. Two countries which initially do not hold comparative cost differences can specialise in industries if economies of scale can be achieved as introduction of one will lead to introduction of the other. Therefore economies of scale is the only opposition to different endowment of factor resources fully explaining countries differences in comparative costs. ...read more.

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