HCI_H1_ECONS_EssayQ4_ans

HWA CHONG INSTITUTION C2 Preliminary Examination 2016 Higher 1 Economics Essay Question 4 Suggested Answer 4 (a) Explain how benefits to the economy can arise from specialisation and trade. (b) Discuss whether specialisation and trade will always improve the standard of living in a country. Part (a) Suggested Essay Outline Introduction - An economy can benefit from specialisation and trade (exchange) and is explained by the law of comparative advantage. - The Law of Comparative Advantage states that trade or in this question, exchange, can benefit all countries if they specialise in the goods in which they have a comparative advantage in the production of a good, that is, she can produce the good at a lower opportunity cost than another country. Body - State the assumptions Production of textiles and cars before specialization and trade Opportunity Cost of producing 1 unit of Production with: USA: Partial Specialise with 75% resources in cars and 25% in textile Vietnam: Full specialization in textile Consumption after trade by exchanging 12T for 12C TOT: 1T:1C Countries Textiles Cars Textile s Cars Textiles Cars Textile s Cars USA 20 30 3/2 C 2/3 T 10 45 22 33 Vietnam 15 10 2/3 C 3/2 T 30 0 18 12 World 35 40 40 45 40 45  Before specialization, USA produces 20 units of textiles and 30 units of cars which means it has to give up 3/2 unit of cars for 1 unit of textile or 2/3 unit of textiles for 1 car.  On the other hand, Vietnam produces 15 units of textiles and 10 units of cars which means it has to give up 2/3 unit of cars for 1 unit of textiles or 3/2 unit of textiles for 1 unit of car.  This implies that USA and Vietnam have a lower opportunity cost or comparative advantage in producing cars and textiles respectively.  Assuming USA will have partial specialization in cars using 75% of resources and 25% of resources in textiles while Vietnam goes into full specialization in textiles. Specialisation will

results in mass production and enable the firms and industry to grow and thus enjoy both internal and external economies of scale.  USA will produce 10 units of textiles and 45 units of cars and Vietnam will produce 30 units of textiles only.  These countries will agree to trade if the terms of trade lie between: 2/3 cars < 1 textile < 3/2 cars or 2/3 textiles < 1 car < 3/2 textiles. Terms of trade (TOT) measures the rate of exchange of one good or service. The exact terms of trade will depend on the strength of demand and the relative bargaining powers of the countries involved.  Assuming they agree on the terms of trade of 1 unit of textiles to 1 unit of cars and exchange 12 units of textiles for 12 units of cars.  After specialization and trade, USA gains 2 and 3 units of textiles and cars respectively and Vietnam gain 3 and 2 units of textiles and cars respectively. The world output also increases by 5 units each for textiles and cars.  It is