Principles of Economic Essay Example | Topics and Well Written Essays - 3500 words

Principles of Economic - Essay Example If both countries are closed economies, i.e., they do not participate in any trade then both countries will produce both goods by allocating half of their resources to each of the goods, tomatoes and clothes in our case. Consider the hypothetical table below: They cannot produce entire amounts of both goods at the same time. However, participating in international trade and specialization can help increase their production possibilities. Since Pakistan is better at cloth production while Germany is better at tomatoes production, Pakistan is said to have an absolute advantage in cloth production and Germany in tomatoes production. Therefore, common sense suggests that each should specialize in the good in which they have an absolute advantage and as a result, each of them would be better off than they were before. This means that Pakistan should produce 400 clothes and no tomatoes and Germany should produce 400 tomatoes and no clothes. Therefore, Pakistan can now import 200 tomatoes from Germany while Germany can import 200 clothes from Pakistan, thereby each of them realizing a gain of 150 from international trade and specialization. Clearly there is a gain from international trade and specialization in the form of increased production possibilities. ... Therefore, Pakistan can now import 200 tomatoes from Germany while Germany can import 200 clothes from Pakistan, thereby each of them realizing a gain of 150 from international trade and specialization. Cloth Tomatoes Total production (without trade) 250 250 Total production (with trade) 400 400 Clearly there is a gain from international trade and specialization in the form of increased production possibilities. However, even when, for instance, Germany has an absolute advantage in the production of both tomatoes and clothes, participating in international trade and specialization can increase its production possibilities and increase world trade. The theory of comparative advantage says that it should specialize in those goods which it can produce with relatively greater efficiency and import the other. However, we must remember that the above was based on two countries and two products only. In the real world, there are many products and countries involved. However, this model can be extended to include any number of countries or products. Other assumptions are also involved such as production costs are constant and there are no restrictions on international trade. In reality, this is not true. Nevertheless, we can conclude that international trade and specialization can increase world trade through the theories of absolute and comparative advantage. Q2 (a) (i) Price of Mangoes - $ / kg Quantity Demanded - 000/kg Quantity supplied-000/kg $6.00 220 400 $5.50 240 360 $5.00 260 320 $4.50 280 280 $4.00 300 240 $3.50 320 200 $3.00 340 160 Equilibrium quantity= 280000