International Trade and Protectionism: Question 10
Syllabus 6.1
(a) State what is meant by the term comparative advantage. [2]
(b) Country M has an opportunity cost of producing one unit of Good J equal to 2 units of Good K. Country N has an opportunity cost of producing one unit of Good J equal to 5 units of Good K. State, with a reason, which country has the comparative advantage in producing Good J. [2]
(c) Explain one assumption made by the theory of comparative advantage that may limit how well it explains real-world trade patterns. [3]
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Worked solution
Part (a): Defining comparative advantage
Comparative advantage exists when a country can produce a good at a lower opportunity cost, giving up less of other goods, than another country can, even if that country is not the most productive (does not have the absolute advantage) at making the good. It is a relative concept: it compares how much of one good must be sacrificed to produce another, rather than comparing raw output levels between countries.
Part (b): Applying the opportunity costs given
Country M’s opportunity cost of one unit of Good J is 2 units of Good K, while Country N’s opportunity cost of one unit of Good J is 5 units of Good K. Since , Country M gives up relatively less of Good K to produce Good J, so Country M has the comparative advantage in producing Good J.
Part (c): An assumption that limits the theory
The theory of comparative advantage assumes that there are no transport costs (or other costs of trading) between countries (goods can be moved from the exporting country to the importing country for free. In reality, shipping goods internationally is costly, and these costs must be paid on top of the price of the good itself. If transport costs are large enough, they can eat into or completely wipe out the cost advantage that comparative advantage predicts, meaning the theory can overstate the real-world gains from specialisation and trade. (Other assumptions with similar effects include constant opportunity costs regardless of the scale of production, and factors of production being perfectly mobile between industries within each country) neither of which always holds in practice.)
Final answers
- (a) Comparative advantage producing a good at a lower opportunity cost than another country, even without the absolute advantage.
- (b) Country M has the comparative advantage in Good J (opportunity cost of 2 < 5 units of Good K).
- (c) The theory assumes no transport costs between countries, which is unrealistic and can reduce the real-world gains from trade.