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Structured Response a) + b) on Absolute Advantage, Comparative Advantage and Trade ( [8] + [12] marks, 45 minutes)

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Introduction

Transfer-Encoding: chunked 1. In a two country world, one country is more efficient at producing one product and the other country is more efficient at producing another product, explain why specialisation and trade usually benefit both countries. [8] In the case where a country can produce a given product more efficiently than another, it means that the country happens to have an absolute advantage in the production of said good, hence, if both countries allocate equal amounts of resources to the production of said good, the country with the absolute advantage will be able to produce more of it. This absolute advantage can be due to a number of reasons ranging from factor endowment, making it easier for a country to harvest the raw materials required for the production of a good, pre-existing infrastructure providing the framework for more efficient production or higher levels of education leading to greater worker productivity. In turn, given that one country has an absolute advantage in the production of one good while the other has an absolute advantage in the production of the other, a comparative advantage for both countries arises in the production of the good that they are more efficient at producing, meaning that they can produce the good at a lower opportunity cost than the other country, thus creating a basis for trade. ...read more.

Middle

However, despite this, there may still be a basis for trade due to comparative advantage. As seen in table, Country A can only produce coal at an opportunity cost to oil of 1 : 2, however, Country B can produce the coal at an opportunity cost of 2 : 1. Thus, Country B will have a comparative advantage in the production of coal despite being less efficient at it. After specialisation and trade at a ratio of 1 : 1 as seen in table 4, both countries can serve to benefit, Country B can consume an extra 100 units of coal if maintaining the same consumption level of Oil as seen in table 3, or an extra 100 units of Oil if it maintains the same level of coal consumption. Similarly, country B can also consume an extra 100 units of coal following the specialisation and trade, thus creating a mutually beneficial situation, where, despite the absolute advantage of Country A in the production of both goods, both countries can still benefit from trade. One key benefit of this trade would be the increase in the potential quantities of each good consumed in each country due to the implementation of a trading possibility curve showing the maximum combination of goods that can be consumed following specialisation and trade. ...read more.

Conclusion

This could then lead to a substantial shortage problems, particularly if any of the countries is highly dependent on the consumption of oil, perhaps due to a need to use petrol consuming vehicles as a result of a large surface area. In this case, one or both of the countries would end up suffering falls in welfare as the total amount of oil available for consumption would fall, hence making trade on the basis of comparative advantage beneficial only to a certain extent, at least within the theoretical example of bilateral trade in a two country world. Overall, while not always beneficial, trade on the basis of comparative advantage will likely be mutually beneficial to both countries provided that the difference in the opportunity costs are substantial, the trading is done at a ratio between the two opportunity costs and provided that the costs omitted within the analysis are not substantial enough as to outweigh the potential benefits. It is also likely to be most effective in consumer good industries as many countries will likely be reluctant to trade a strategic industry such as military armaments or agriculture despite comparative advantages elsewhere. Table 3: Output of Coal Output of Oil Country A 300 600 Country B 200 100 Total output 500 700 Table 4: Output of Coal Output of Oil Country A 200 800 Country B 400 0 Total Output 600 800 ...read more.

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