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Suppose 1 country was more efficient at producing both products. Discuss whether it is the case that specialisation and trade will always benefit both countries.

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Introduction

´╗┐Suppose 1 country was more efficient at producing both products. Discuss whether it is the case that specialisation and trade will always benefit both countries. When 1 country is more efficient at producing both products, specialisation and trade will still benefit both countries to a large extent if there are differing opportunity costs between the 2 countries. When 1 country has lower opportunity costs in producing the good than the other, it means that it has a comparative advantage. This is explained in the table below. Assume 2 countries have the same amount of labour: 100 workers. The table below represents the output of 2 different goods they produce. Guns (50 labourers) Roses (50 labourers) ...read more.

Middle

However the opportunity cost of producing a gun in country A is 2 roses whereas the opportunity cost of producing a gun in country B is 3 roses. This means that A has a comparative advantage in producing guns. Thus A should specialise in producing guns and B in roses and trade can still be beneficial. This can be elaborated with an example. Imagine after specialisation, A will produce 200 guns and B will produce 300 roses. Now A decides to trade at an exchange rate of 1 gun for 2.5 roses and decides to trade 100 guns and gain 250 roses. ...read more.

Conclusion

Secondly, even with comparative advantages and specialisation, the exchange rate of the 2 goods must lie between the 2 countries? opportunity costs. In this particular case, for trade to be beneficial for both countries, the exchange rate should be 2 roses < 1 gun < 3 roses. Lastly, the theory of comparative advantage assumes constant opportunity costs within an economy (straight line PPC curves). However, in real life, it is usually not so as opportunity costs are increasing (convex PPC). Therefore with increasing opportunity costs in a country, specialisation may not benefit after all as we are sacrificing efficiency, substituting less efficient factors of production for more efficient ones. ...read more.

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