SRJC_H2_ECONS_9757_Q6_MS

Q6. Many people feel that free trade is unfair. Some blame it for the loss of jobs; others for worsening balance of payments deficit. Source: adapted from World Economic Forum. (a) Explain how free trade helps to alleviate the problem of scarcity. [10] (b) Assess the relevance of protectionism in view of the statement above. [15] SUGGESTED ANSWERS TO PART A Introduction Clarify key terms: Scarcity arises because there are limited economic resources but unlimited human wants. Thus, resources are scarce or insufficient to satisfy all wants. Without free trade, each country would have to be self-sufficient and can only consume what it can produce with its given resources. Direction: Free trade is needed to extend a nation’s consumption possibility frontier beyond its production possibility frontier i.e. it enables the people in the country to consume more goods and services than what the country could produce on its own. Hence, the Theory of Comparative Advantage can be used to explain how free trade alleviate the problem of scarcity. Body P1: Countries should specialize and trade goods which they have comparative advantage in arising from differences in factor endowments as they can benefit in terms of efficiency in resource allocation.  A country is said to have comparative advantage in the production of a good if it can produce that good at a lower opportunity cost than another country.  The opportunity cost of producing Good X is the amount of the other good which has to be sacrificed in order to produce an additional unit of Good X.  The assumptions are there are two countries in the world, USA and China, producing two goods, cloth and wheat. Both countries have the same amount of resources which are fully employed and equally divided between the productions of both good s before specialisation. There are constant returns to scale and perfect mobility of factors of production within the country. Transport cost is negligible and there is free trade between the two countries. Table 1 below shows the possible output before specialization. Country/Goods Cloth (metre) Wheat (kg) USA 500 500 China 400 100 World 900 600 From Table 1, we can see that by dividing their resources equally in the production of wheat and cloth, USA can produce 500m of cloth and 500kg of wheat. To produce 1 more unit of cloth, the resources for wheat production has to be channelled to produce more cloth. As a result, the output of wheat falls by 1kg. So the opportunity cost of producing 1 m of cloth in USA is 1 kg of wheat. China can produce 400m of cloth and 100kg of wheat. By the same reasoning, China’s opportunity cost of producing 1 m of cloth is 0.25 kg of wheat. Since China incurs a lower opportunity cost of produ cing cloth, China is said to have a comparative advantage in the production of cloth. Hence, China will specialise in cloth production. According to the Theory of Comparative Advantage, b