Specialisation & Trade (Edexcel A Level Economics A)

Absolute & Comparative Advantage

• International trade decreases prices and increases the variety of goods/services available to a nation

  • This results in a higher standard of living

• Comparative advantage is the theory developed by David Ricardo in 1817 which states that a country should specialise in the goods/services that it can produce at the lowest opportunity cost

  • By specialising, the volume of production increases

  • Excess production can be exported

  • Goods/services which are not produced in the country can be imported

• Absolute advantage occurs when a country is able to produce a product using fewer factors of production than another country

  • A country may well have absolute advantage but still not have comparative advantage

    • It should produce goods/services in which it has comparative advantage

The assumptions of comparative advantage

• As with any economic model, there are underlying assumptions to the theory of comparative advantage

1. Transport costs are zero: it does not account for moving the goods/services between countries. Depending on a nation's location this is more or less of a problem

2. There is perfect knowledge: each country knows what it has a comparative advantage in and also the comparative advantages of other countries

3. Factor substitution is easily achieved: economies can quickly adjust to changing global market conditions by switching from capital to labour - and vice versa

4. Constant costs of production: the theory does not take into account the economies of scale that can be achieved with an increase in output

Using production possibility frontiers to Illustrate comparative and absolute advantage

• Production possibility frontiers can be used to illustrate these concepts

The production possibility frontiers for 2 countries who both produce t-shirts and computer chips

Diagram analysis

• Country A has an absolute advantage as it can produce more of both products

• Country A can produce either 200,000 t-shirts or 100,000 computer chips

  • To produce 100,000 computer chips, it gives up production of 200,000 t-shirts
    

  • The opportunity cost of producing 1 computer chip is 2 t-shirts 
    

  • The opportunity cost of producing 1 t-shirt is 0.5 computer chip

• Country B can produce either 80,000 t-shirts or 80,000 computer chips

  • To produce 80,000 computer chips it gives up production of 80,000 t-shirts
    

  • The opportunity cost of producing 1 computer chip is 1 t-shirts 

• The opportunity cost of producing 1 t-shirt is 1 computer chip

• To produce 1 computer chip Country A gives up 2 t-shirts and Country B gives up 1 t-shirt

  • Country B has a comparative advantage in producing computer chips as it is giving up fewer t-shirts and so it should specialise in computer chip production

• To produce 1 t-shirt Country A gives up 0.5 computer chips and Country B gives up 1 computer chip

  • Country A has a comparative advantage in producing t-shirts as it is giving up fewer computer chips and so it should specialise in t-shirt production

Limitations to the theory of comparative advantage

• Comparative advantage does tend to be one of the main factors that drives a nation's manufacturing in a global economy. However, there are limitations and drawbacks to the theory

The Limitations of Comparative Advantage

Advantages & Disadvantages of International Specialisation & Trade

• The advantages of international specialisation and trade are significant and are backed up by the large increase in the volume of global trade in the past fifty years

1. Lower prices

2. Greater variety of goods/services

3. More competition leads to better quality products

4. Economies of scale create efficiencies

5. Higher economic growth

6. Improved living standards

The Disadvantages of Specialisation and Trade