Comparative Advantage in Trade
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Comparative Advantage in Trade

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Questions and Answers

What concept did David Ricardo introduce to expand upon Adam Smith’s theory?

  • Absolute advantage
  • Market equilibrium
  • Trade surplus
  • Comparative advantage (correct)

    • If a country has an absolute advantage in everything, what does the text suggest?

  • Trade is irrelevant in such cases.
  • Only the absolute advantage matters in trade.
  • There still might be reasons to trade. (correct)
  • It should refrain from trade.

    • Which of the following is NOT a reason for a country to engage in trade?

  • Absence of any production advantage (correct)
  • To obtain goods not produced domestically
  • Enhancing economic efficiency
  • Production costs are lower elsewhere

    • What was a significant factor that allows countries to benefit from trade, according to comparative advantage theory?

    <p>Variations in productivity.</p> Signup and view all the answers

    What does the production possibility frontier (PPF) illustrate?

    <p>The maximum production levels of two commodities using available resources</p> Signup and view all the answers

    What is indicated by a PPF that is bowed outward from the origin?

    <p>Increasing opportunity costs as production increases</p> Signup and view all the answers

    What happens if an economy is operating below the PPF?

    <p>It is losing potential output due to inefficiencies</p> Signup and view all the answers

    What does a point outside the PPF represent?

    <p>Unattainable production levels with current resources and technology</p> Signup and view all the answers

    What does the slope of the PPF represent?

    <p>The cost of producing one good in terms of the other</p> Signup and view all the answers

    Which scenario reflects specialization leading to increased economic welfare?

    <p>Concentrating on the good where there is a comparative advantage</p> Signup and view all the answers

    How does the shape of the PPF relate to the cost structure?

    <p>It can be convex or concave depending on costs</p> Signup and view all the answers

    What does efficient production on the PPF imply about resource allocation?

    <p>Resources are maximally utilized without waste</p> Signup and view all the answers

    What does intra-industry trade refer to?

    <p>Trade occurring within the same industry.</p> Signup and view all the answers

    Which trade theory attempts to explain the patterns that traditional theories could not?

    <p>Linder's overlapping demand theory</p> Signup and view all the answers

    Why do new trade theories emerge, according to the content?

    <p>To accommodate changing economic circumstances.</p> Signup and view all the answers

    What is a key characteristic of classical trade theories mentioned in the content?

    <p>They were complete and well-structured.</p> Signup and view all the answers

    Which of the following is not listed as a modern trade theory?

    <p>Heckscher-Ohlin's theory</p> Signup and view all the answers

    What is meant by comparative advantage in the context of new trade theories?

    <p>It continues to hold relevance under new frameworks.</p> Signup and view all the answers

    Which theory is associated with explaining economies of scale in international trade?

    <p>Krugman's theory</p> Signup and view all the answers

    What did the emergence of intra-industry trade show about traditional trade theories?

    <p>They were limited in their ability to explain all trade dynamics.</p> Signup and view all the answers

    What does comparative advantage still affect in modern economies?

    <p>The ability to consume desired product quality</p> Signup and view all the answers

    Which theory posits that not all trade is absent between low-income and high-income countries?

    <p>Linder’s theory of demand</p> Signup and view all the answers

    What economic condition is NOT considered part of the Ricardian framework of comparative advantage?

    <p>Government intervention</p> Signup and view all the answers

    Which of the following assumptions has become untenable in modern economies according to the text?

    <p>Constant returns to scale</p> Signup and view all the answers

    What was emphasized as lacking in ‘perfect’ competition?

    <p>Atomistic competition between small firms</p> Signup and view all the answers

    Which economic concept did Paul Krugman discuss in relation to trade?

    <p>Economies of scale</p> Signup and view all the answers

    Modern economists began to develop models of trade based on which aspect?

    <p>Intra-industry trade dynamics</p> Signup and view all the answers

    What is a critical factor for many new industries in modern economies according to Krugman?

    <p>Returns to scale</p> Signup and view all the answers

    What drives trade according to Krugman's approach?

    <p>Internal economies of scale</p> Signup and view all the answers

    What happens to a firm's average cost as total output increases in the presence of internal economies of scale?

    <p>It decreases</p> Signup and view all the answers

    What is a primary reason for a firm to differentiate its product in a monopolistically competitive market?

    <p>To compete for profits</p> Signup and view all the answers

    Under what condition are new entrants unlikely to enter the market?

    <p>When the price is equal to the average cost</p> Signup and view all the answers

    What characterizes the market when it is mentioned that there are 'fewer firms' producing more?

    <p>Monopolistic competition</p> Signup and view all the answers

    What assumption does Krugman's model make about the preferences among individuals in the economy?

    <p>They have the same utility function</p> Signup and view all the answers

    What factor primarily defines the total number of firms in Krugman's model?

    <p>The average cost and the market price</p> Signup and view all the answers

    What occurs when a firm produces output that allows them to spread high fixed costs?

    <p>Internal economies of scale</p> Signup and view all the answers

    Study Notes

    Comparative Advantage

    • David Ricardo expanded on Adam Smith's theory of absolute advantage in trade by introducing the idea of comparative advantage, which means that a country can benefit from specializing in producing goods where it has a lower opportunity cost, even if another country has an absolute advantage in producing both goods.
    • Ricardo argued that a country can import goods even if it could produce them more efficiently at home, as long as it specializes in the goods where it has a comparative advantage.
    • The opportunity cost of producing a good is the amount of another good that must be given up to produce one more unit of the first good.
    • This concept helps explain why countries trade with each other, even when they have different levels of productivity.
    • The Production Possibilities Frontier (PPF) shows the maximum possible output of two different goods that can be produced with a given set of resources and technology.
    • The slope of the PPF reflects the opportunity cost of producing one good in terms of the other good.
    • A point within the PPF represents an inefficient allocation of resources, while a point outside the PPF is unattainable with current resources and technology.
    • The PPF can be used to illustrate the concept of comparative advantage, showing how specialization and trade can lead to higher levels of output and welfare.

    New Trade Theories

    • Twentieth-century trade patterns, including intra-industry trade (trade within the same industry) began to emerge, which classical trade theories, including Ricardo's model, struggled to explain.
    • New trade theories were developed that focused on explaining these new patterns of trade, including Linder's Theory, Economies of Scale (Krugman), Technology Gap, and Product Lifecycle Theories (Posner & Vernon).
    • Despite the prominence of these new theories, the classical theory of comparative advantage remained relevant, providing a foundation for understanding the underlying factors that drive trade patterns.

    Linder's Theory

    • The theory suggests that trade is driven by similar preferences and demand structures between countries, with more trade occurring between countries that share similar tastes and income levels.
    • Linder's theory suggests that countries with similar levels of income and demand for certain goods are more likely to trade those goods with each other.

    Krugman’s Economies of Scale

    • Krugman's theory focused on the role of economies of scale in driving trade, highlighting the importance of large-scale production and decreasing average costs.
    • His model helps to explain intra-industry trade (trade within the same industry) that is not explained by traditional comparative advantage theories.
    • Krugman's theory relaxes traditional assumptions of perfect competition and constant returns to scale, acknowledging the prevalence of imperfect competition and increasing returns to scale in modern economies.
    • His model suggests that countries with similar levels of income and demand for certain goods are more likely to trade those goods with each other, allowing for greater production efficiency and lower costs.

    Key Assumptions

    • The concept of economies of scale plays a critical role: A firm's average cost per unit of output falls as total output increases.
    • Imperfectly competitive (monopolistic) markets are where firms have some control over pricing, leading to fewer firms and greater production by each firm.
    • Product differentiation strategies are employed by firms to distinguish their offerings to compete in the market.
    • Entry into the market is restricted for new firms due to high fixed costs and the need for a product price higher than the average cost to recover initial investments.

    Impact of Economies of Scale on Trade

    • Economies of scale, imperfect competition, and international trade lead to increased efficiency and economic welfare.
    • Trade allows firms to expand their production and exploit economies of scale, leading to lower prices and increased variety of products available for consumers.

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    Description

    Explore the concept of comparative advantage introduced by David Ricardo, which highlights how countries benefit from specializing in goods with lower opportunity costs. Understand the importance of the Production Possibilities Frontier (PPF) in illustrating trade and production efficiency. This quiz will challenge your knowledge about trade principles and opportunity costs.

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