International Trade, Globalisation and Exchange Rates: Question 2

Worked solution

Part (a): Defining specialisation by country

Specialisation by country means a country focuses its resources (land, labour, capital and enterprise) on producing the particular good(s) or service(s) it is best suited to produce, either because it can do so at the lowest cost or because it makes the most efficient use of its available resources. Instead of every country trying to produce everything it needs, each specialises and then trades with other countries for the goods and services it does not produce itself.

Part (b): Matching each country to its lowest-cost good

The passage gives each country a clear resource-based reason to specialise in a different good:

• Verantia has fertile highland soil and a climate suited to coffee, so it can grow coffee at a lower cost than it could produce cloth.
• Kastoria has advanced textile factories and a skilled, experienced workforce, so it can produce cloth at a lower cost than it could grow coffee.

If the two countries trade freely, there is no need for either to keep producing the good it makes less efficiently. Verantia can specialise fully in coffee, Kastoria can specialise fully in cloth, and each can import the good the other produces more cheaply. This means resources in both countries are allocated to their best use, and overall output of both coffee and cloth is likely to be higher than if each country tried to produce both goods for itself.

Part (c): An advantage and a disadvantage of specialising in coffee

Advantage: Because Verantia’s land and climate suit coffee growing far more than cloth production, specialising in coffee lets Verantia make the most efficient use of its resources. It can produce a larger volume of coffee than if it also had to devote land, labour and capital to cloth-making, and it can import cloth from Kastoria more cheaply than it could produce it domestically. The result is a greater total quantity of goods available to Verantia’s consumers than if the country tried to be self-sufficient in both goods, raising living standards.

Disadvantage: Specialising narrows the range of goods Verantia produces and exports. If Verantia comes to rely heavily on coffee for its export revenue, it becomes vulnerable to a fall in the world price of coffee or a fall in world demand for coffee (for example, if consumer tastes shift, or if a competing country starts producing coffee more cheaply). Because Verantia no longer maintains its own cloth industry, it has no other major export to fall back on if coffee earnings fall, so its income and government tax revenue can become more unstable than if it produced a wider range of goods.

Final answers

• (a) Specialisation by country: focusing a country’s resources on producing the good(s) it can produce most efficiently or cheaply, and trading for the rest.
• (b) Verantia specialises in coffee (suited by soil and climate) and Kastoria in cloth (suited by factories and skilled labour), since free trade lets each import the good it would otherwise produce at higher cost.
• (c) Advantage: more efficient use of resources and greater total output/consumption. Disadvantage: dependence on a narrow range of exports (coffee) leaves Verantia vulnerable to falls in coffee’s world price or demand.