at the end of the lesson you should be able to: identify the 3 conditions of identify the 3 conditions of trade trade identify the limitations of identify the limitations of the theory of the theory of absolute/comparative absolute/comparative advantage advantage

Conditions of trade: 1)The terms of trade (TOT) must lie between the two domestic opportunity cost ratios 2)The exchange rate (ER) must lie between the two domestic opportunity cost 3) The O.C. ratios must differ

Limitations of theory: 1. Non price theory Trade is not necessarily based on price alone but other non-price aspects such as quality High costs producers can still sell their goods if their quality is better

Limitations of theory: 2. Perfect factor mobility In practice, there is likely to be a certain amount of factor immobility. when country X shifts production from cloth to wheat, labour is not easily redeployed to the wheat industry causes unemployment in cloth industry

Limitations of theory: 3. Constant cost is unlikely theory is ignoring the possibility of diseconomies of scale (DEOS) and diminishing returns as output expands which can lead to higher average cost On the other hand, increasing returns can lead to lower average cost

Limitations of theory: 4Barriers to trade and transport cost trade barriers such as the imposition of tariffs and quotas transportations cost etc. have not been factored into model. these cause SS to fallP may restrict trade n specialization

Benefits of Trade and Globalization

1. Efficient allocation of resource. Principle of comparative advantage – most efficient producer produces the good cost P

2 Foreign competition improves quality of Goods and Services

3 Exports generates higher Income - Economic Growth & higher SOL

4 Specialization & large scale production output EOS lower average cost P

5 increase in productivity & creation of new products/industry as inputs not available locally can be readily imported

6 Increase in variety of goods and services