I Wish I Wish
Outline the theory of comparative advantage (CA) as applied to international trade. (12)
A country is said to have comparative advantage over a good when it can produce the good at a lower opportunity cost. According to the theory of comparative advantage, a country should specialize in the good, which incur a lower opportunity cost. Opportunity cost is known as the extent of which you sacrifice one good for the other. This concept of comparative advantage with the use of opportunity cost can be further illustrated using a numerical example.
Taking two families, the Tans and the Lims for which both families collect water and catch fishes. The Tan family is able to collect 2units of water and 3units of fish while the Lim family is able to collect 3units of water and 6nits of fish. This information can be put into a table form.
Tans 2water 3fish
Lims 3water 6fish
Total 5water 9fish
The opportunity cost for collecting 1unit of water is 1.5units of fish for the Tans and 2units of fish for the Lims. On the other hand, the opportunity cost for catching 1unit of fish is 2/3units of water for the Tans and 0.5units of water for the Lims. Therefore, the Tans has a lower opportunity cost in collecting water and should thus specialize in collecting water while the Lims has a lower opportunity cost in catching fish and should thus specialize in catching fish.
The theory of comparative advantage also states that all countries can benefit from specialization and trade even though one country has absolute advantage in all goods. Thus, to benefit, each country should specialize in the good, which the country has a lower opportunity cost in producing as mentioned earlier. To determine the comparative advantage of the country, we have to look at the country’s factor of endowment. Given that different countries have different factor of endowment give rise to the benefits of specialization and trade. A country with more labour resources such as Vietnam will has comparative advantage over labour-intensive good such as textile while a country with more capital resources will has comparative advantage over capital-intensive good such as car. Hence, based on this theory o comparative advantage, we shall see how it will give rise to benefits for the country.
The first benefit will be that world production of all goods will increase. This can be further elaborated with the help of a numerical example. 2unitsof resources are divided equally into countries, USA and Vietnam to produce 2goods,car and textile. Given that USA is able to produce 100unitsof textile and 50units of car given its resources and Vietnam is able to produce 80units of textile and 10nits of car, the total production will be 180units of textile and 60units of car.
USA 100textile 50car
Vietnam 80textile 10car
Total 180textile 60car
From the summarized information, we can see that USA has absolute advantage over the two goods. However, it does not mean that USA has comparative advantage over both textile and car. To look at the comparative advantage of each good for each country, we have to look at the opportunity cost in producing the two goods for both USA and Vietnam.
The opportunity cost for producing 1unit of textile is 0.5units of car for USA and 0.125units of car for Vietnam. Thus, Vietnam has a lower opportunity cost in producing textile. On the other hand, the opportunity cost for producing 1unit of car is 2units of textile for USA and 8units of textile for Vietnam. Thus, USA has a relatively lower opportunity cost in producing car. As such, USA should specialize in the production of car and Vietnam should specialize in the production of textile since USA has comparative advantage in producing car and Vietnam has comparative advantage in producing textile. Point to note that even though USA should specialize in the production of car, it should not utilize all its resources onto car but should specialize partially since it has absolute advantage over both goods. USA should allocate more of it resources to production of car and a smaller proportion for textile.
After specialization, total production for both goods can be summarized in a table form.
USA 30textile 85car
Vietnam 160textile 0car
Total 190textile 85car
Therefore, total production of car increase to 85units from the previously 6ounits and textile increase to 190units form the previously 180units. Thus, we can conclude that world production of all goods can rise due to specialization based on this example.
In addition, specialization also increases consumption that leads to a higher standard of living (SOL). SOL refers to the material and non-material well being of average citizens of a country. In this case, we’re focusing more on the material well being of the people, which include the consumption of consumer goods and services such as clothing and food.
After countries specialize in the goods they have comparative advantage in, they will trade with each other. The agreement of trade will be base on the term of trade (TOT).
TOT measures the amount for which one good is exchange for the other. The TOT should lie in between the opportunity cost of each of the trading country in producing the goods. Based on the earlier example, the opportunity cost for producing 1unit of car is 2units of textile for USA and 8units for Vietnam. As such, the TOT for 1unit of car should lie in between 2 to 8 units of textile. From this agreement, USA has enjoyed at least 3units of textile for 1car and Vietnam only has to give up the most 7units of textile for 1unit of car. Thus, both countries get to enjoy more goods and this will lead to higher SOL for both countries.
In conclusion, based on the theory of comparative advantage, as countries specialize in line with their lower opportunity cost, countries will be able to enjoy more goods and services and thus enjoy higher SOL. Furthermore, world production can increase and this leads to a more efficient use of scarce economic resources.
In the light of this theory, is protectionism ever justified? (13)
From the earlier discussion, we see how specialization and trade can give rise to benefits for countries. Thus, based on the theory of comparative advantage, it seems that protectionism cannot be justified. However, there are some assumptions applied. It is assumed that the term of trade (TOT) is mutually beneficial, economic resources are perfectly mobile and all countries agreed with the trade. Furthermore, comparative advantage can change over time as state of technology of countries change. As such, protectionism can be justified to protect infant industries, home employment and reduce balance of payments (BOP) deficit.
Protectionism is justified to protect infant industries. Infant industries are industries that do not have comparative advantage currently but have the potential to grow in the future. Protecting infant industries are important, as they are unable to complete with the more establish foreign firms and may die out. These infant industries may have the potential to grow and gain comparative advantage in the future, which will bring about higher employment, economic growth and healthier BOP. Infant industries can also help the country to diversify into other industries. For instance, Singapore is moving from the electronics sector to the biomedical sector, especially pharmaceutical sector. Even within the electronics industries, Singapore is moving towards producing better quality product such as plastic camera lens module. Diversification helps to reduce country’s reliance on a certain industry. However, protecting infant industries may cause the industries to be too dependent on the protectionism and not grow on its own. This is a waste of scare economic resources. Also, the government may also identify the wrong infant industry to protect.
As such, it is important to note that the government identifies the correct industry to protect and should be ready to let go of the industry if it proves to be inefficient even with protectionism. The protectionism should also be of a fixed period of time in order to prevent the infant industry from becoming too dependent. It will be better to provide financial help to the industry than to involve protectionism.
Furthermore, protectionism is justified to protect home employment. Sometimes, unemployment can arise when domestic firms cannot complete with the more establish foreign firms and close down or lose out. Such unemployment problem can get so serious that it will destabilize the country’s economy. This can happens when the domestic firms are faces with higher cost of production (e.g. high wage) as compare to the foreign firms. It can also be due to dumping by foreign firms. Dumping takes place when foreign firms sell their goods prices lower than their cost of production.
As such, protectionism is justified to give time for domestic firms to reorganize and restructure their industries to increase competitiveness and to phase out some declining domestic industries to allow them time for retraining to increase productivity. Protectionism is also justified if dumping is of vicious intention to drive out domestic firms.
In line with the justification of protectionism, it is also used to reduce BOP deficit. When a country’s import is more than its export, its expenditure is more than its recipient. This will lead to a BOP deficit when the value of visible import is higher than visible export. Depreciation in the BOP will cause the country’s exchange rate to depreciate and this will give rise to undesirable problems such as rising cost-push inflation as imported raw materials become more expensive and also falling national income. As such, it s important to reduce the threat of rising imports due to specialization and trade and protectionism can be justified.
In conclusion, even though specialization and trade is much beneficial from the arising benefits on the countries, it is important to examine the problems, which can come about. Especially for the developing countries where encouraging the growth of domestic firms and reduce reliance on foreign companies for investment and economic growth is of a more important aim, protectionism can still be justified to achieve macroeconomic aims such as high economic growth, low inflation rate and low unemployment rate.
I jus have to practise econs here.
I Wish Upon a Star on Sunday, June 10, 2007
International Trade
Outline the theory of comparative advantage (CA) as applied to international trade. (12)
A country is said to have comparative advantage over a good when it can produce the good at a lower opportunity cost. According to the theory of comparative advantage, a country should specialize in the good, which incur a lower opportunity cost. Opportunity cost is known as the extent of which you sacrifice one good for the other. This concept of comparative advantage with the use of opportunity cost can be further illustrated using a numerical example.
Taking two families, the Tans and the Lims for which both families collect water and catch fishes. The Tan family is able to collect 2units of water and 3units of fish while the Lim family is able to collect 3units of water and 6nits of fish. This information can be put into a table form.
Tans 2water 3fish
Lims 3water 6fish
Total 5water 9fish
The opportunity cost for collecting 1unit of water is 1.5units of fish for the Tans and 2units of fish for the Lims. On the other hand, the opportunity cost for catching 1unit of fish is 2/3units of water for the Tans and 0.5units of water for the Lims. Therefore, the Tans has a lower opportunity cost in collecting water and should thus specialize in collecting water while the Lims has a lower opportunity cost in catching fish and should thus specialize in catching fish.
The theory of comparative advantage also states that all countries can benefit from specialization and trade even though one country has absolute advantage in all goods. Thus, to benefit, each country should specialize in the good, which the country has a lower opportunity cost in producing as mentioned earlier. To determine the comparative advantage of the country, we have to look at the country’s factor of endowment. Given that different countries have different factor of endowment give rise to the benefits of specialization and trade. A country with more labour resources such as Vietnam will has comparative advantage over labour-intensive good such as textile while a country with more capital resources will has comparative advantage over capital-intensive good such as car. Hence, based on this theory o comparative advantage, we shall see how it will give rise to benefits for the country.
The first benefit will be that world production of all goods will increase. This can be further elaborated with the help of a numerical example. 2unitsof resources are divided equally into countries, USA and Vietnam to produce 2goods,car and textile. Given that USA is able to produce 100unitsof textile and 50units of car given its resources and Vietnam is able to produce 80units of textile and 10nits of car, the total production will be 180units of textile and 60units of car.
USA 100textile 50car
Vietnam 80textile 10car
Total 180textile 60car
From the summarized information, we can see that USA has absolute advantage over the two goods. However, it does not mean that USA has comparative advantage over both textile and car. To look at the comparative advantage of each good for each country, we have to look at the opportunity cost in producing the two goods for both USA and Vietnam.
The opportunity cost for producing 1unit of textile is 0.5units of car for USA and 0.125units of car for Vietnam. Thus, Vietnam has a lower opportunity cost in producing textile. On the other hand, the opportunity cost for producing 1unit of car is 2units of textile for USA and 8units of textile for Vietnam. Thus, USA has a relatively lower opportunity cost in producing car. As such, USA should specialize in the production of car and Vietnam should specialize in the production of textile since USA has comparative advantage in producing car and Vietnam has comparative advantage in producing textile. Point to note that even though USA should specialize in the production of car, it should not utilize all its resources onto car but should specialize partially since it has absolute advantage over both goods. USA should allocate more of it resources to production of car and a smaller proportion for textile.
After specialization, total production for both goods can be summarized in a table form.
USA 30textile 85car
Vietnam 160textile 0car
Total 190textile 85car
Therefore, total production of car increase to 85units from the previously 6ounits and textile increase to 190units form the previously 180units. Thus, we can conclude that world production of all goods can rise due to specialization based on this example.
In addition, specialization also increases consumption that leads to a higher standard of living (SOL). SOL refers to the material and non-material well being of average citizens of a country. In this case, we’re focusing more on the material well being of the people, which include the consumption of consumer goods and services such as clothing and food.
After countries specialize in the goods they have comparative advantage in, they will trade with each other. The agreement of trade will be base on the term of trade (TOT).
TOT measures the amount for which one good is exchange for the other. The TOT should lie in between the opportunity cost of each of the trading country in producing the goods. Based on the earlier example, the opportunity cost for producing 1unit of car is 2units of textile for USA and 8units for Vietnam. As such, the TOT for 1unit of car should lie in between 2 to 8 units of textile. From this agreement, USA has enjoyed at least 3units of textile for 1car and Vietnam only has to give up the most 7units of textile for 1unit of car. Thus, both countries get to enjoy more goods and this will lead to higher SOL for both countries.
In conclusion, based on the theory of comparative advantage, as countries specialize in line with their lower opportunity cost, countries will be able to enjoy more goods and services and thus enjoy higher SOL. Furthermore, world production can increase and this leads to a more efficient use of scarce economic resources.
In the light of this theory, is protectionism ever justified? (13)
From the earlier discussion, we see how specialization and trade can give rise to benefits for countries. Thus, based on the theory of comparative advantage, it seems that protectionism cannot be justified. However, there are some assumptions applied. It is assumed that the term of trade (TOT) is mutually beneficial, economic resources are perfectly mobile and all countries agreed with the trade. Furthermore, comparative advantage can change over time as state of technology of countries change. As such, protectionism can be justified to protect infant industries, home employment and reduce balance of payments (BOP) deficit.
Protectionism is justified to protect infant industries. Infant industries are industries that do not have comparative advantage currently but have the potential to grow in the future. Protecting infant industries are important, as they are unable to complete with the more establish foreign firms and may die out. These infant industries may have the potential to grow and gain comparative advantage in the future, which will bring about higher employment, economic growth and healthier BOP. Infant industries can also help the country to diversify into other industries. For instance, Singapore is moving from the electronics sector to the biomedical sector, especially pharmaceutical sector. Even within the electronics industries, Singapore is moving towards producing better quality product such as plastic camera lens module. Diversification helps to reduce country’s reliance on a certain industry. However, protecting infant industries may cause the industries to be too dependent on the protectionism and not grow on its own. This is a waste of scare economic resources. Also, the government may also identify the wrong infant industry to protect.
As such, it is important to note that the government identifies the correct industry to protect and should be ready to let go of the industry if it proves to be inefficient even with protectionism. The protectionism should also be of a fixed period of time in order to prevent the infant industry from becoming too dependent. It will be better to provide financial help to the industry than to involve protectionism.
Furthermore, protectionism is justified to protect home employment. Sometimes, unemployment can arise when domestic firms cannot complete with the more establish foreign firms and close down or lose out. Such unemployment problem can get so serious that it will destabilize the country’s economy. This can happens when the domestic firms are faces with higher cost of production (e.g. high wage) as compare to the foreign firms. It can also be due to dumping by foreign firms. Dumping takes place when foreign firms sell their goods prices lower than their cost of production.
As such, protectionism is justified to give time for domestic firms to reorganize and restructure their industries to increase competitiveness and to phase out some declining domestic industries to allow them time for retraining to increase productivity. Protectionism is also justified if dumping is of vicious intention to drive out domestic firms.
In line with the justification of protectionism, it is also used to reduce BOP deficit. When a country’s import is more than its export, its expenditure is more than its recipient. This will lead to a BOP deficit when the value of visible import is higher than visible export. Depreciation in the BOP will cause the country’s exchange rate to depreciate and this will give rise to undesirable problems such as rising cost-push inflation as imported raw materials become more expensive and also falling national income. As such, it s important to reduce the threat of rising imports due to specialization and trade and protectionism can be justified.
In conclusion, even though specialization and trade is much beneficial from the arising benefits on the countries, it is important to examine the problems, which can come about. Especially for the developing countries where encouraging the growth of domestic firms and reduce reliance on foreign companies for investment and economic growth is of a more important aim, protectionism can still be justified to achieve macroeconomic aims such as high economic growth, low inflation rate and low unemployment rate.
I jus have to practise econs here.
I Wish Upon a Star on Sunday, June 10, 2007