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4. International economics

4. International economics - Why do countries trade...

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Why do countries trade? Countries trade because it makes sense to specialise. This is an extension of the division of labour argument. One past professor of economics even refused to use countries as an example because the point was so obvious. Towns, he said, trade with each other because it pays them to do so, countries are no different. With specialisation, economies of scale are achieved. A country may also have people with special skill, an abundance of a specific raw material, or special climatic conditions. Therefore they can produce some goods or services more efficiently than other counties. The surplus produced through specialisation can then be traded for a good or service from another country. For example, the Scots trade Scotch whisky for tropical spices from Indonesia. A country is said to have an absolute advantage over another in the production of a good if it can produce it with fewer resources. However, even if a country does not have an absolute advantage, it will always have a comparative advantage in something. And countries will still benefit from trade. Comparative Advantage Let us assume that there are only two countries and that they each produce only two goods - cloth and wine. It seems obvious that they should specialise in producing the good that they are most efficient at (i.e. they have an absolute advantage in). But what if one country is more efficient at producing both goods. Assume that a given amount of land, labour and capital is used by each country. The following  table shows how much they can produce. From the table you will see that the developed  country has an absolute advantage in producing both products. Wine Cloth Developed Country 4 or 8 Less Developed Country 2 or 1 Using this information we can calculate the opportunity cost of producing each product in each country. To produce 1 unit of wine means the developed country foregoes 2 units of cloth giving an opportunity cost of 2. Developed country Opportunity cost cost of producing 1 cloth 0.5 wine cost of producing 1 wine 2 cloth Less Developed country cost of producing 1 cloth 2 cost of producing 1 wine 0.5 A country has a comparative advantage in that product with the lowest opportunity cost of production, so The LDC should specialise in wine and the DC should specialise in cloth. To
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start, assume that both countries do not  trade, and they each use 50% of their resources making  wheat and 50% making wine. Wine Cloth Developed Country 2 and 4 Less Developed Country 1 and 0.5 Total 3 4.5 Above, the total production for the world is 3 wine and 4.5 cloth = 7.5. Now what happens if  each country specialises and uses all of its resources just to produce the product it has a  comparative advantage in?
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4. International economics - Why do countries trade...

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