International Trade Grade 13 IBDP

International Trade Think, Pair Share List 5 reasons why Nations Trade with each other What factors influence what commodities, goods and services are traded? List 5 factors that help/are an aid to trade List 5 factors that can be considered to be barriers to trade.

The Law of Absolute Advantage The principle of absolute advantage refers to the ability of a party (an individual, or firm, or country) to produce more of a good or service than competitors, using the same amount of resources. Adam Smith first described the principle of absolute advantage in the context of international trade, using labour as the only input. Adam Smithinternational trade Since absolute advantage is determined by a simple comparison of labor productivities, it is possible for a party to have no absolute advantage in anything; [7] in that case, according to the theory of absolute advantage, no trade will occur with the other party. [8] It can be contrasted with the concept of comparative advantage which refers to the ability to produce a particular good at a lower opportunity cost. labor productivities [7] [8]comparative advantage opportunity cost Look at table 23.1 on P247 explaining how this works using 2 countries Australia & China and 2 commodities lamb and cloth.

The Law of Comparative Advantage First introduced by David Ricardo in 1817, comparative advantage exists when a country has a ‘margin of superiority’ in the production of a good or service i.e. where the marginal cost of production is lower. Countries will usually specialise in and then export products, which use intensively the factors inputs, which they are most abundantly endowed. If each country specialises in those goods and services where they have an advantage, then total output can be increased leading to an improvement in allocative efficiency and economic welfare. Put another way, trade allows each country to specialise in the production of those products that it can produce most efficiently (i.e. those where it has a comparative advantage). This is true even if one nation has an absolute advantage over another country. So for example the Canadian economy which is rich in low cost land is able to exploit this by specialising in agricultural production. The dynamic Asian economies including China have focused their resources in exporting low-cost manufactured goods which take advantage of much lower unit labour costs. In highly developed countries, the comparative advantage is shifting towards specialising in producing and exporting high-value and high-technology manufactured goods and high-knowledge services. Table 23.2 page 248. Read pages 247 – 249, complete workpoint 23.2 on P249.

Limitations of The Law of Comparative Advantage Assumes Perfect Competition Assumes zero transport costs Assumes only 2 economies – bilateral trade Assumes constant returns to scale Assumes goods traded are identical in quality Assumed only goods are traded and FoP stay in their country – labour & capital are now geographically mobile Assumes no Government trade restrictions P251, answer Q1 & Q2