4.1.2

• absolute advantage is when a country can produce more of a good or service with the same amount of resources than another country
• absolute advantage - Adam Smith 1776 "wealth of nations"
• comparative advantage is when a country can produce a good at a lower opportunity cost
• for trade to benefit both parties, the terms of trade must fall between the two countries opportunity costs
• Ricardo's theory of comparative advantage assumes:

  • perfect factor mobility
  • no transportation costs
  • no trade barriers
  • perfect competition in market
  • full employment of resources
  • model uses only two countries and two goods
• Ricardo's theory of comparative advantage limitations:

  • transport costs can reduce the benefits of trade
  • imperfect factor mobility
  • comparative advantages change over time
  • trade barriers do exist
  • externalities are accounted for
  • not all countries benefit equally from trade
• specialisation and trade means that there is greater output as global production increases through efficient resource allocation
• specialisation and trade leads to consumption beyond the PPF - countries can consume combinations of goods beyond their PPF
• specialisation and trade leads to greater variety of goods and services for consumers
• specialisation and trade leads to economies of scale - larger markets allow for more efficient production
• specialisation and trade means there is more competition - leads to lower prices and innovation
• specialisation and trade there are flows of foreign direct investment (FDIs) - boost economic development
• specialisation and trade can lead to structural unemployment - workers in declining industries may struggle to find new jobs
• there is a risk of being over specialised - can be vulnerable to changes in global demand or prices
• increased specialisation and trade harms the environment from increased transportation and extraction of raw materials
• more trade = loss of culture - loss of traditional industries or skills
• the benefits of trade are unequally distributed within countries - inequality
• loss of culture from increased trade as it brings in more foreign ideas and products into the country
• loss of sovereignty from joining trade blocs and signing deals/treaties
• labour theory of value (David Ricardo) - the value of goods/services is measured by the amount of labour needed to produce it
• neo classical price theory suggests that labour AND scarcity determine value of good/service
• comparative advantage illustrates how world output can increase if countries start to specialise in what they are best at producing
• more trade - widens consumer choice - can buy from world markets, not just domestic ones - increases consumer welfare as some prefer to buy foreign goods
• increased trade - overdependent on exports - if demand price of their exports fall - fall in GDP