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at the end of the lesson at the end of the lesson you should be able to:you should be able to:
• identify the 3 identify the 3 conditions of conditions of trade trade
• identify the identify the limitations of limitations of the theory of the theory of absolute/comparative absolute/comparative advantageadvantage
Conditions of trade:Conditions of trade:1)The terms of trade (TOT)
must lie between the two domestic opportunity cost ratios
2)The exchange rate (ER) must lie between the two domestic opportunity cost
3) The O.C. ratios must
differ
Limitations of theory:Limitations of theory:1. Non price theory • Trade is not necessarily
based on price alone but other non-price aspects such as quality
• High costs producers can still sell their goods if their quality is better
Limitations of Limitations of theory:theory:
2. Perfect factor mobility • In practice, there is likely
to be a certain amount of factor immobility.
• when country X shifts production from cloth to wheat, labour is not easily redeployed to the wheat industry
• causes unemployment in cloth industry
Limitations of theory:Limitations of theory:3. Constant cost is unlikely• theory is ignoring the
possibility of diseconomies of scale (DEOS) and diminishing returns as output expands which can lead to higher average cost
• On the other hand, increasing returns can lead to lower average cost
Limitations of theory:Limitations of theory:4 Barriers to trade and
transport cost• trade barriers such as the
imposition of tariffs and quotas
• transportations cost etc. have not been factored into model.
• these cause SS to fall P may restrict trade n
specialization
Benefits of Benefits of Trade and Trade and
GlobalizationGlobalization
11 ..Efficient allocation Efficient allocation
of resource.of resource.Principle of Principle of
comparative comparative advantage – most advantage – most efficient producer efficient producer
produces the good produces the good cost cost PP
22Foreign Foreign
competition competition improves quality improves quality
of Goods and of Goods and ServicesServices
33Exports Exports
generates higher generates higher Income Income - -
Economic Growth Economic Growth & higher SOL& higher SOL
44Specialization & Specialization &
large scale large scale productionproduction output output
EOS EOS lower lower average costaverage cost
PP
55increase in productivity increase in productivity
& creation of new & creation of new products/industryproducts/industry
as inputs not available as inputs not available locally can be readily locally can be readily
importedimported
6 6 Increase in Increase in
variety of goods variety of goods and servicesand services