Theory question 104
International Trade(a) State and explain the law of comparative cost advantage.
(b) Give two limitations of the law as a theory of international trade.
Show the model answer
(a) The law states that even if one country is more efficient than another in producing all goods, both gain from trade if each specialises in producing the good in which it has the greater relative advantage (lowest opportunity cost) and trades for the other. Explain with an example of two countries and two goods.
(b) Any two: it assumes no transport costs; assumes free trade (ignores tariffs and quotas); assumes perfect mobility of factors within a country and immobility between countries; assumes constant costs (ignores diminishing returns); considers only two countries and two goods; assumes full employment; ignores the need for self-sufficiency in strategic goods.
Use opportunity cost to show which country should specialise in which good.