Page 42 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes equilibrium e*. Country A has moved along the production possibility curve to e*, where it is producing
more cloth and less wheat. It has specialised in cloth at the expense of wheat because it is assumed to
have a comparative advantage in cloth.
Exports of cloth trade at the more favourable international opportunity cost represented by TT’. TT’
is determined by supply and demand conditions for wheat and cloth in country A and country B. To
arrive at the post-trade equilibrium for country A, move out along TT’ until a point of tangency is
reached with a higher indifference curve II’, at e’. At this point, country A’s marginal rate of substitution
in consumption (slope of II’) is equal to the marginal rate of transformation in production (slope of nn’),
and is equal to the relative prices of wheat and cloth in international markets (slope of TT’). II’ represents
a higher level of real income for country A. Foreign trade, which has led to specialisation and exchange,
results in a higher level of real income at the new post-trade equilibrium e’.
Self-Assessment
1. Choose the correct options
(i) Which of the following key principles of economics can best explain the benefits from
specialization?
(a) The real-nominal principle.
(b) The principle of voluntary exchange.
(c) The principle of opportunity cost.
(d) The marginal principle
(e) The principle of diminishing returns.
(ii) According to the theory of comparative advantage, specialization and free trade will benefit
(a) only the owner of a monopoly.
(b) all trading parties who specialize in the production of the good in which they have a
comparative advantage.
(c) only that trading party that has an absolute advantage in the production of all goods.
(d) only the party which specializes the least.
(e) only the party which specializes the most.
(iii) Along the production possibilities curve, specialization and trade usually leads to a move in
which the country in question:
(a) produces more of both goods.
(b) produces more of one good and less of another.
(c) produces and exchanges less of both goods.
(d) produces less of both goods but exchanges more of both goods with another country.
(iv) Which of the following IS NOT a reason for the increase in productivity that comes with
specialization?
(a) Repetition. (b) Continuity.
(c) Innovation. (d) Creative destruction.
(v) Market systems are desirable because
(a) they facilitate exchange and specialization.
(b) people cannot be self-sufficient.
(c) exchange cannot take place without markets.
(d) then everyone pays the same amount in taxes.
(e) producers cannot specialize without markets.

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