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Unformatted text preview: Economics 2003-04: International Economics Page 1 SECTION 4: INTERNATIONAL ECONOMICS 4.1 REASONS FOR TRADE Trade is based on the concept of opportunity cost: if a country can produce one good at a lower opportunity cost than another country, it has a comparative advantage. It sacrifices less of other goods to make one unit of that good. Gains from trade are the increased output resulting from specialization amongst nations and from trading are called the gains from trade. They lead to an increase in living standards, but also to increased dependence amongst nations. Absolute Advantage A country has an absolute advantage in the production of a good if an equal quantity of resources can produce more of the good than another country. An absolute advantage does not confer a comparative advantage: in order to produce that good, it may take fewer resources but it might also involve a greater sacrifice of other goods. Example: given a unit of resources, India can make 10 bushels of wheat or 6 metres of cotton cloth, while Kenya can make 5 bushels of wheat or 10 metres of cloth. If one unit of resource is switched into making wheat in India and into making cloth in Kenya, the gains, losses and net gains are illustrated in the bottom part of the table. The countries combined produce more wheat and cloth than if they were self- sufficient; to receive a benefit they must trade. Comparative Advantage Comparative advantage: one country is relatively more efficient at producing one good, even if the other country is absolutely more efficient at producing both goods. Example: India is 10 times more productive, but relative to Kenya, India is more efficient at Absolute advantage Wheat Cloth India 10 6 Kenya 5 10 Gains from Trade India +10-6 Kenya-5 +10 GAIN +5 +4 Comparative Advantage Wheat Cloth India 100 60 Kenya 5 10 Gains from Trade India +10-6 Kenya-5 +10 GAIN +5 +4 Page 2 Economics 2003-04: International Economics producing wheat than cloth. India can produce 20 times more wheat than Kenya but only 6 times more cloth. India has a comparative advantage in producing wheat while Kenya has a comparative advantage in producing cloth. One tenth of a unit of resources is transferred from cloth to wheat in India while one unit of resources is transferred from wheat to cloth in Kenya. Gains from trade are positive, both countries can benefit from specializing....
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