Principles of absolute & Comparative Advantage

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  • Created by: cynchuah
  • Created on: 13-06-16 13:39

Absolute Advantage

A country has in production of a g/s if it can produce it using fewer resources & at a lower cost than another country,

  • 2 countries-2 guds model
  • Assumptions:

1. Production & opportunity cost r constant for each product.

  • A country is said to have ~ in production of a gud if it can produce more of gud than another country having same amount of resources.
  • This country is more efficient in production of that gud.
  • Country will specialise in production of gud for which it has an ~.
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Principles of International Trade

  • Trade occurs when countries have a clear-cut/absolute advantage over other countries.
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Comparative Advantage

  • Even though a country may have absolute advantage in production of both guds, trade can still be mutually beneficial when countries specialise based on principle of ~.
  • A country has ~ if it can produce gud at a lower opportunity cost.
  • Multi-lateral free trade is beneficial for overall well-being of world economy.
  • It ensures that guds r produced in those countries that r most efficient, hence, minimising waste of resources,
  • Restrictions on trade will reduce gains from free trade.
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Assumptions of Principles

  • PPFs r linear,
  • Exchange rates must be within respective domestic opportunity cost ratios. Greater difference btw opportunity costs, greater potential for trade.
  • No transport costs r charged.
  • 2-country, 2-guds assumption is unrealistic.
  • Production costs r unlikely to be constant. As countries specialise, they benefit from economies of scale.
  • No restrictions on free trade
  • Resources r mobile
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