HCI_H2_ECONS_Essays_ans

HWA CHONG INSTITUTION C2 Preliminary Examination 2016 Higher 2 Economics Paper 2 Essays Suggested Answers Question 1 (a) Explain how free trade helps to alleviate the problem of scarcity. [10] (b) In the recent decades, technological advan cement has helped to promote the spread of information and economic integration has facilitated labour migration. Discuss the extent to which the above events could help to reduce resource misallocation arising from imperfect information and immobility of factors of production. [15] Part (a) Introduction: Using the theory of Comparative Advantage, we will be illustrating how a country’s problem of scarcity may be reduced. Body: 1) Theory of CA  The Law of Comparative Advantage states that trade 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.  The illustration of the Law of Comparative Ad vantage is based on the following assumptions: ‐ Only 2 countries are involved in the pr oduction and exchange of 2 commodities. ‐ Each country has 10 units of re sources and devotes half of her resources among the production of the 2 goods. ‐ There is constant opportunity co sts of production of the goods. ‐ There are no transport costs, which might out weigh the benefits of specialisation and trade. ‐ There are no restrictions to trade (protectionism). ‐ There is perfect factor mobility within each countr y and factor immobility between countries (otherwise no need for trade). ‐ There are no emergencies or political or strat egic reasons for a country to produce a good with the higher comparative cost. Production of textiles and cars before specialization and trade Opportunity Cost of producing 1 unit of Production with: DC: Partial Specialise with 75% resources in cars and 25% in textile LDC: Full specialization in textile Consumption after trade by exchanging 12T for 12C TOT: 1T:1C Countries Textiles Cars Textiles Cars Textiles Cars Textiles Cars Developed Country (DC) 20 30 3/2 C 2/3 T 10 45 22 33 Less Developed Country (LDC) 15 10 2/3 C 3/2 T 30 0 18 12 World 35 40 40 45 40 45  Although DC is able to produce more of both goods than LDC.  Both countries can still gain from trade if they specia lize according to their comparative advantage which is determined by their opportunity cost in production or relative efficiency in producing the good.  Before specialization, DC 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, LDC 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 DC and LDC have a lower o