A2 Economics Aims and Objectives Aim Understand the theory of absolute and comparative advantage Objectives Define the theory of absolute and comparative advantage Analyse the effects of specialisation ID: 130946
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Slide1
Absolute and Comparative Advantage
A2 EconomicsSlide2
Aims and Objectives
Aim:
Understand the theory of absolute and comparative advantage.
Objectives:
• Define the theory of absolute
and comparative advantage.Analyse the effects of specialisationEvaluate the case for free tradeSlide3
Starter
What is the UK current account?
Do we have a deficit on the CA? Have we always had a deficit on the CA?
Is the UK trade deficit important?Slide4
Absolute Advantage
China & RussiaSlide5
Absolute Advantage
Two countries
Produce just two commodities – guns
and
oil.
Each country has 10 units of resourcesUsing all resources they can produce the output shown:
China
Russia
Oil
400
320
or
or
Guns
400
160Slide6
Absolute Advantage
Trading (Production) possibility diagram:
0 100 200 300 400
100
2
00
3
00
4
00
China has an absolute advantage in the production of both guns and oil.
Absolute Advantage: where a country using a given resource input is able to produce more than other countries with the same input.
China
RussiaSlide7
Self Sufficiency
If each country was self-sufficient and did not trade (closed economy) the output would be shown as follows:
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280Slide8
Comparative Advantage
China & RussiaSlide9
Comparative Advantage
While Russia has an absolute disadvantage compared to China, it still benefits countries to specialise in the production of a good or service.
Theoretical basis for free trade is comparative advantage.
Comparative Advantage: where a country can produce a good with a lower input cost than other countries. Therefore global resources can be allocated more efficiently.Slide10
Comparative Advantage
Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Gun = 1 Oil Barrel
1 Oil Barrel = 0.5 Gun
1 Gun = 2 Oil Barrel
These
op.cost
ratios show Russia has a comparative adv. in oil, as to produce an extra unit of oil it only has to give up half a gun compared to 1 gun for China. Slide11
Comparative Advantage
Opportunity costs in each country:
1 Oil Barrel = 1 Gun
1 Gun = 1 Oil Barrel
1 Oil Barrel = 0.5 Gun
1 Gun = 2 Oil Barrels
However, China has a comparative advantage in guns as to produce an extra gun it only has to give up 1 unit of oil, compared to 2 units for Russia.Slide12
Comparative Advantage
Differences in comparative adv. and op. cost give rise to international trade, where countries specialise in the area where they have the greatest comparative adv.
China
Russia
Total Output
Oil
0
320
320
Guns
400
0
400
SPECIALISATIONSlide13
However, the output of oil has fallen from 360 to 320. Partial specialisation can be used to rectify this…..
China
Russia
Total Output
Oil
0
320
320
Guns
400
0
400
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280Slide14
Comparative Advantage
Original Economies Output
Partially Specialised Economies Output
China
Russia
Total Output
Oil
60
320
380
Guns
340
0
340
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280Slide15
Therefore, total output of oil has increased from 360 to 380 whilst the production of guns has also increased from 280 to 340. International trade has led to an increase in total supply of both products and economic welfare will increase in both countries.
China
Russia
Total Output
Oil
200
160
360
Guns
200
80
280
China
Russia
Total Output
Oil
60
320
380
Guns
340
0
340Slide16
Plenary
Define and give examples of comparative and absolute advantage.
Should specific countries specialise in the sole production of just a few goods, for which they possess a comparative advantage?