Comparative Advantage

Question 1

Give an example of comparative advantage in the real world.

Answer 1

For example, two salesmen. Both have a task of producing both coffee and selling sales. One salesmen may be good at both making coffee and selling sales, more than his colleague in one hour. This means that this first salesman has absolute advantage. The second salesmen who may only be able to make 3/4 of the amount of coffee and 1/2 the amount of sales has a comparative advantage, as he has a lower opportunity cost. This means in order to maximise output, the first salesman should focus on sales as there is a high opportunity cost (greater loss of sales) if he focuses on coffee, the second salesman should sell coffee as he has a lower opportunity cost for selling coffee (there would be a greater loss in sales). This is called specialisation. The impact will be that total output increases. Total output will increase if the first and second salesmen both produce the goods in which they have a comparative advantage. This same concept applies to what countries decide to produce in order to increase their world output

Question 2

What does a PPF show?

Answer 2

A production possibility frontier shows the maximum potential output of the economy, using all resources efficiently

Question 3

Give an example of comparative advantage in terms of countries.

Answer 3

Applying this to countries: the opportunity cost for Uzbekistan supplying frankfurters and not cashmere is 0.1, however the opportunity cost of Germany supplying cashmere and not frankfurters is 1.25. This means Urz has a lower opportunity cost for supplying frankfurters, this gives them comparative advantage. While Germany has an absolute advantage for supplying both cashmere and frankfurters as the opportunity cost for both countries is 1. Therefore Urz should specialise in cashmere and Germany should specialise in frankfurters

Question 4

Define absolute advantage

Answer 4

A country has an absolute advantage in the production of a good when it can produce more of that good than another country

Question 5

How does comparative advantage affect world output?

Answer 5

If countries specialise in a good for which they have comparative advantage, then total world output will increase

Question 6

Define comparative advantage

Answer 6

A country has a comparative advantage in the production of a good if they can produce it at a lower opportunity cost than another country

Question 7

What are the assumptions of the theory of comparative advantage - what limitations do they cause?

Answer 7

1) Assumes that the average cost of production is constant - e.g. Martin Winkler CEO of German sock company falke isn’t want to use Chinese mulberry silk anymore but less expensive and working class cashmere socks, G had just scrapped cashmere production in favour of Frankfurt production. Uzbekistan specialises in cashmere, martin made the first assumption that average cost of production stays constant. Turns out Uzbekistans specialisation in cashmere had led to diseconomies of scale (Alienation, Bureaucracy, and communication. As workers become alienated in a big company their productivity falls and this increases the average cost). This made production process more expensive and cashmere less available. So assumption is incorrect as increased specialisation might result in rising average costs caused by diseconomies of scale.
2) No trade barriers - a restriction placed by a gov on the import of foreign goods (Tariff). Trade barriers may distort comparative advantage. Winkler went to purchase cashmere from Uzbekistan but found when he put his home country as Germany the price rose as he had to pay the tax to the gov for the imported goods. Meant that they could not purchase as much cashmere to trade barriers disrupted comparative advantage.
3) No transport costs - Winkler put his home address, with 5,000km between the countries are 40euros/kg. So transport costs may distort comparative advantage

Question 8

What are the 3 advantages of specialisation and trade?

Answer 8

1) Specialisation leads to higher world output and so higher living standards - when the UK and china saw they had a comparative advantage of making certain goods, led to UK specialising in paracetamol tablets and china in more steel -> total output increased, increasing world GDP and improving world living standards. HOWEVER, Winkler finding that the prices increased due to tariffs, less demand, total output decreases, real world gdp decreases
2) Trade creates a larger market which allows firms to reduce their average costs - Specialisation and trade may create economies of scale - as Dubai Arabia discovered its oil reserves in 1938, and is the largest oil reserves in the world. Comparative advantage encouraged Saudi to specialise in oil production and other countries less oil so that Saudi could sell lots to other countries. The more factors of production Saudi put into its oil production, the cheaper to produce it became due to economies of scale, so quantity of oil sold increased, long run average cost decreased and profits increased. These profits were reinvested back into the Saudi economy and so their real GDP grew rapidly e.g. 1970s real gdp of Saudi grew by over 20% per annum
3) Specialisation and trade can lead to lower prices and more choice for consumers. Trading with other countries give that country a greater choice of goods. BY trading with other countries the UK can enjoy foreign goods that are hard to grow in the UK such as avocados from California. When the UK purchases these California can specialise and increase output, leading to economies of scale which can reduce production costs. This would cause a rightward shift in SRAS

Question 9

What are 3 disadvantages of specialisation and trade?

Answer 9

1) The benefits of speculation and trade are based on unrealistic assumptions. Increasing average cost/ having trade barriers/ having transport costs will all increase the price of imports, which will decrease demand for that good, decrease total output and decrease real world GDP
2) May lead to overdependence on imports and exports - e.g. 2009 Russia cut off its large supply of gas to large parts of Europe in response to a worsening of relationship between R and Ukraine. This was bad on Bulgaria as they receive most of their gas from Russia, in 2009 the gas shortages forced Bulgaria to cease production in some important factories which slowed economic growth (imports issue).
For exports: Saudis gas and oil exports now account for 50% of their real GDP, so their economy is not diversified and so it is vulnerable. When their oil runs out, 50% of their GDP will disappear so their economy is at serious risk, they already have unemployment rising and real GDP falling. Saudi Prince released Saudi vision 2030 which hoped to reduce dependence on oil but this process will be slow and may have been quicker if they had not specialised
3) May lead to demotivation, decreasing productivity and increasing prices. First limitation of theory of comparative advantage is that increased specialisation might increase output and lead to rising average costs caused by diseconomies of scale. Diseconomies of scale occur when an increase in output increases the long-run average cost. While theoretically specialisation and trade should decrease price level, in reality it can cause alienation of workers, can make it more bureaucratic and cause poor communication which will all cause the prices to increase

Question 10

What are the 5 characteristics of globalisation?

Answer 10

1) Increased international movement of labour - when an American chef moves from America to France to cook french cuisine they move their labour to France, when French IT technician moves to India to join a new software company they move their labour from France to India. As mobilisation has increased, international movement of labour has also increased.before globalisation almost everyone lived in the country they were born in, but in 2024, over 5 million people from the UK lived and worked in other countries. More than 3.7% of global population lived outside country of birth in 2024.
2) Increased international movement of financial capital - (financial capital is money used for investment), e.g. old multibilllion dollar cotton company TATA in India wanted to expand in more capital like harvesters for cotton picking they used this financial capital to buy harvesters, eventually cotton became scarce. TATA looked to UK for more profitable investment opportunities. In 2008, TATA paid £1.7bn to buy/acquire UK car company Jaguar, this was FDI, TATA had to move financial capital from India to UK through FDI. As globalisation has increased, international movement of financial capital has increased significantly including an increase in FDI. An estimated $144bn went into china in 2017 while about $85bn went into Hong Kong
3) Increased specialisation - when a country can produce more of a good than another it has absolute advantage. If a country has a comparative advantage for making a good (lower opportunity cost) then the theory of comparative advantage says that they should specialise more in that good. Different countries specialise in different things due to different climates or resources, therefore goods such as avocados from Mexico have been imported into the UK, the UK cannot grow them well but specialises in pharmaceuticals and so in return exports these. Increased globalisation causes an increase in specialisation e.g. Saudi in oil production, now oil and gas sector accounts for 50% of their real GDP. In Zambia, specialised in copper, cooper exports account for 30% of their real GDP
4) Increased international trade - e.g. after years of working on a tour bus, a worker then sells souvenirs in London to tourists after buying a shop. This workers sales are an example of an export of a good. The good is exported because money is flowing into the economy from foreign tourists. The worker used Wix to set up a website, Wix is Israeli and his business is in London. This website maker is a service rather than a good as you are not buying a tangible product. Wix is a service that is imported because Greg is buying it from a foreign firm - money is therefore flowing out of the economy. Wiz serves over 190 countries and has offices globally including America, making it a TNC (trans National Corporation - this is when a country operates in 2 or more countries). Another example is an investment banker working in Goldman Sachs in London is writing a contract for a German transnational corporation, their work is an export of a service as it is money flowing into the economy after selling her services to a foreign firm. The worker makes lots of bonuses from this and so buys an Italian Ferrari, this is an import of a good, as they are buying from a foreign firm.
Therefore, as globalisation has increased over the years, international trade has increased significantly. Now 80% of the international trade is driven by transnational corporations
5) Increased trade-to-GDP ratios - This ratio shows how high the value of international trade is compared to the size of a countries economy. This higher the ratio, the more important international trade to survive. The USA’s trade to GDP ratio in 2023 was around 25% so there weren’t completely dependent on international trade, in contrast Luxembourg’s ratio was >400% (more than 400%) so there international trade was extremely important. To find the trade to GDP ratio, do the (total value of trade/GDP) x100. A decrease in GDP will cause an increase in the trade-to-GDP ratio

Question 11

Define globalisation

Answer 11

The interconnectiveness and interdependence of countries

Question 12

Define FDI

Answer 12

An investment made by a firm in one country into a firm in another country, to gain control over the foreign firm

Question 13

What are transnational corporations and give some examples?

Answer 13

A company that operates in two or more countries . They base manufacturing, assembly, research and retail operations in several countries

Many TNCs have become synonymous with globalisation such as Nike, Apple, Vodafone, Netflix, Uber, Amazon, Facebook (Meta) Google and Samsung
TNC’s are key driver of globalisation because many have been re-locating manufacturing to countries with relatively lower unit labour costs in order to increase their SNP and equity returns for shareholders. Some transnationals are now restoring (back to country of origin) manufacturing as labour costs rise in many emerging countries. The Pandemic has also caused some firms to shorten their manufacturing supply chains
Example of transnational corporations; Tata group from India has made significant investments in Western economies including Jaguar Land Rover
TNC’s are major contributors to FDI, often establishing subsidiaries (company controlled by parent company) in foreign countries
According to WTO, around 2/3rds of global trade is now conducted within multinational enterprises or their subsidiaries

Question 14

Causes of globalisation? (4)

Answer 14

1) Improvements in transport - availability in speed and commercial plane flights has made It easier for workers to move countries, so more workers are travelling to work abroad. E.g. it used to take 5 weeks to travel from London to Sydney by boat and now it takes 21 hours to fly there. So improvements in transport have lead to increased international movement of labour
2) Improvements in IT - in the 1930s if the Indian company TATA had wanted to move financial capital to the UK to purchase British car company jaguar, they would have had to use a telegraph or write a letter, then corresponded for weeks, then TATA would have to go to local bank fill out paperwork and wait more weeks until UK received the paperwork. Nowadays they can find an email address, get a quick response then arrange a virtual meeting, then arrange payment by PayPal or other financial services - so developments of the internet, such as meetings and PayPal, have caused in increase in the international movement of financial capital
3) Containerisation - If worker in London souvenirs stall wanted to import 10,000 British teddy bears from china in 1950 they would have travelled through a slow and expensive process and likely some dock workers may steal some. Malcom McLean in 1956 invented metal containers so dock workers didn’t need to spend hours loading individual crates as a machine can unload these larger ones quickly, at the time it was calculated the cost per tonne in each container was $0.16, which was a large decrease from the $5.83 cost previously prior to the containers, this caused shipping costs to decrease. This decrease in shipping costs causes a rightward shift of supply as worker with souvenirs can afford to ship more, the increase in supply would cause the price of beefeater teddy bears to decrease, and the QD to increase. So there is an increase of international trade. The system of transporting goods in these containers is called containerisation and has increased efficiency and decreased costs of shipping goods around the world over the past 50 years, the WTO estimated that containerisation has caused a 790% increase in international trade
4) Trade liberalisation - A trade barrier is a restraint placed by a country on the import of a foreign good. The most common example of a trade barrier is a tariff which is a tax you have to pay when you import a good. For example importing truffles from New Zealand to the UK, you would have to pay a +14.4% tariff alongside price of the truffles. But to import a pure bread Iranian horse there would be a 0% as there is no tariff. When you remove a tariff, the cost of imports decrease so consumers can import more such as New Zealand truffles, and when demand for imports increase, New Zealand would export more truffles leading to an increase in international trade. In the last 50 years many countries have reduced or removed trade barriers leading to an increase in international trade. E.g. average tariff rate was 10% in 1960 and is now 2%

Question 15

What are the impact of Globalisation on individual countries? Pros and Cons

Answer 15

1) Impact on individual countries - Pro - theory of comparative advantage has increased specialisation and therefore increased living standards. Countries such as the UK are able to import iPhones from America and BMW’s from Germany. Developing countries such as Botswana can now import aids medication. In 1950 around 75% of the worlds population were living in extreme poverty but today its less than 10%. Therefore globalisation has improved living standards.
Con -HOWEVER globalisation can also lead to overdependence, the more a country specialises, the more their economies depend on the goods/services they specialise in. E.g. Saudi being dependent on oil and giving up agricultural sector for income to increase their oil and gas output. If Saudi runs out of oil and gas they lose 50% of their GDP

Question 16

What is the impact of globalisation on governments? Pros and cons

Answer 16

Impact on governments - Benefit - increased tax revenues. E.g. in the last 20 years India’s Trade-to-GDP ratio increased by 75%. As countries trade more goods between each other, countries governments collect more tax revenues due to tariffs (a tax on imported foreign goods). The US raised $37.8bn on tax revenues in 2016 through tariffs, this extra revenue can be used to fund government spending which has externalities e.g. in the UK it could fund new London cross rail or education
CON - globalisation results in transfer pricing which causes tax avoidance. E.g. large transnational corporations have been able to avoid paying billions in tax as these large TNC’s often own smaller ‘daughter’ companies which are often owned by one parent company e.g. apple has daughter companies of anobit and beats. These daughter companies are often in different countries which all have different levels of corporation tax (like Ireland), so they can reduce the tax paid and this is called transfer pricing. In 2016 apple got caught transfer pricing unfairly by pushing profits into a daughter company in Ireland where corporation tax was lower, so European Commission ordered them to pay $13bn in unpaid taxes, Global Financial Integrity group estimate several hundred billion dollars of tax is lost each year through transfer pricing

Question 17

What is the impact of globalisation on producers?

Answer 17

Benefit - lower production costs - improvements in transport, IT, containerisation and trade liberalisation all helped countries to relocate their businesses to other countries. For example apple makes the processes for their iPhones in Taiwan to reduce costs. Apple can do this because Taiwan has very low labour costs which reduces production costs for apple. Apple then source the batteries from China and screens from Japan. Today, Chinese wages are 10-25% of UK wages so labour is much cheaper. German company BMW now have an assembly plan in Egypt where land is cheaper.
CON - reduced costs through relocation can be a disadvantage for smaller business, as these reduced costs help TNC’s to create high barriers to entry. Globalisation has allowed TNC’s to access a larger international market e.g. McDonald’s have restaurants in 119 countries, the more food sold their revenue increases and so they benefit from larger economies of scale, specifically purchasing economies of scale; as the Quantity of Big Macs sold increases, the quantity of beef purchased increases so making each piece of beef cheaper, this will reduce their LRAC and so can keep charging lower prices. These lower prices create higher barriers to entry to smaller firms who cannot benefit from the same EoS, so McDonald’s undercut many small businesses and forced them out of businesses. E.g. in France 3,000 small businesses close a year while McDonald’s open many new ones

Question 18

What is the impact of globalisation on consumers?

Answer 18

Benefit - wider choice and lower prices of goods/services. Globalisation has increased international trade and so consumers globally can benefit from wider choice and lower prices e.g. tea from India and beer from Germany. Increased international trade has led to economies of scale globally and help reduce costs, so SRAS shifts will shift right due to a decrease in production costs, this further decreases costs. E.g. USA grocery stores carry around 40K more items than they did 20 years ago
CON - reduced consumer happiness - increased consumption, the more goods/services we consume, the more consumers demand, (Diderot effect - e.g. if you buy a viola you need to buy a bow, then a chin rest, then cleaner for the strings), more driven to demand goods causes fewer positivity faced day-to-day, decreases happiness

Question 19

What is the impact of Globalisation on workers?

Answer 19

Benefit - increased international opportunities for workers, improvements in transport led to an increase in international movement of labour. Youth Unemployment in Bosnia and Herzegovina, if you are about to finish school it would be advised to move elsewhere to find employment such as Germany. In IT it is easy to send over remittances (a transfer of money by a foreign worker to an individual in their home country), more movement in labour, remittances have increased (in 2015 global remittances estimated to be $600Bn dollars. Improvements in transport and IT have therefore increased international opportunities globally as shown by the vast increase in remittances paid
CON - structural unemployment - comparative advantage and trade liberalisation have caused an increase in specialisation so many manufacturing jobs have been transferred to developing countries e.g. Hartlepool used to produce vast quantities of ships and steel, but since globalisation most steel is produced in china, a developing country with a comparative advantage for producing steel, causing steel/ship building workers to have their jobs removed, causing structural unemployment (occurs when the structure of the economy changes. People working in one sector may lose their jobs while another sector expands). Now in Hartlepool 30% of working-ages households have nobody in work

Question 20

What is the impact of Globalisation on the environment?

Answer 20

Benefit - increase in global cooperation to tackle climate change. The increase in globalisation has caused an increase in international trade, meaning economies interdependence has increased, so now strong relationships are important, this means tackling global problems is more possible. This has led to treaties such as the Kyoto Protocol which forces countries to commit to reducing greenhouse gas emissions, between 1990-2012 the countries in this Protocol managed to reduce their greenhouse emissions by 12.5% which was beyond the initial target of 4.7%
CON - increase in global warming - increase in international trade means more transport is needed to move goods around, around 165 million HGV (lorries) journeys in the UK per year, this increase in transport massively increases CO2 emissions, research shows that temperatures could rise by an average of 6% by the year 2100

Question 21

What are some facts about containerisation?

Answer 21

• In 2021, about 1.95 billion metric tons of cargo were shipped globally, up from some 0.1 billion metric tons in 1980
• Between 1980 and 2022, the deadweight tonnage of container ships grew from about 11 million metric tons to roughly 293 million metric tons
• There were 5,574 container ships operating in the world economy in January 2022

Question 22

What does OECD data show about multinational corporations?

Answer 22

In 2019 global trade in intermediate (semifinished) goods accounted for over 50% of total trade. TNCs are at the heart of the creation of global value chains
OECD data shows that foreign affiliates of multinational corporations employ around 60 mil people worldwide but data estimates that revenue losses from tax avoidance could be between $100 billion and $240 billion annually

Question 23

What are the 6 impacts of globalisation?

Answer 23

Individual countries, governments, producers, consumers workers and the environment