Notesale: Turn your study into money

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Q2b MJ 2011
Discuss the accuracy of the definition of public and merit goods as ‘goods that must be provided by the
government’
...
Non-excludability refers to the fact that the consumers cannot be prevented from consuming a public
good once it is provided
...
Non-diminishability refers to the fact that additional consumers do not reduce
the amount left for other consumers
...
Non-rejectability refers to the fact that
consumers cannot refuse to use the good
...

The characteristics of public goods caused them impossible to price
...
This is known as ‘free-rider’ problem
...

With regards to the public goods, they must be provided by the government are due to following reasons
...
Besides, such goods are not exist in the market
without government intervention
...
Without government providing national defence, clearly that country will be in danger
...

On the other hand, merit goods are the goods which have positive externalities associated with it
...
However, when positive externalities are present, the merit goods will be
under-produced
...

As such, the government may intervene through subsidies or legislation to ensure that a higher quantity of the good
or service is produced and consumed
...
Sometimes lack of information about how good the product is for individuals will
result in insufficient market demand
...

With regards to the merit goods, they must be provided by the government are due to following reasons
...
If
merit goods are provided by the government, it helps the poor to be able to afford them
...
Merit goods by contrast with demerit goods, which lead to
consumers’ satisfaction in a short-run will only bring consumers benefit in a long-run
...
Some people may
fail to realise the importance of education such as education can lead to a better job and future
...

In conclusion, ‘goods that must be provided by the government’ is more suitable and accurate for public goods as
compared to merit goods
...
On the other hand, merit goods such as education and healthcare services may still be
provided by private sectors
...


Q3b ON 2014
Discuss whether PED is a more useful concept than YED for a business that is trying to increase its sales revenue
...
It can be calculated using the
following formula:
PED = %QD/%P
Normal goods have negative price elasticity of demand in that the quantity demanded will increase following a
reduction in price and vice versa
...

Knowledge of price elasticity of demand is useful to businesses because it will help in the formulation of pricing
policies
...
Thus, when
demand is price elastic, a business will be able to increase its total revenue by reducing prices as demand will
increase more than proportionately to the reduction in the price
...
Thus, when demand is
price inelastic, a business will be able to increase total revenue by raising prices
...
If the price elasticity of demand for each segment can be accurately determined, the
business will be able to charge the optimal price in each segment to maximize its total revenue beyond what would
have been possible from charging a single price
...

Income elasticity of demand measures the sensitivity of demand to a change in income
...
Inferior goods have negative positive income elasticity as the quantity demanded will decrease
as income increases
...

Knowledge on income elasticity of demand will be useful in indicating the types of goods that businesses should be
focusing on during periods of economic growth or recession
...

In conclusion, price elasticity of demand is more useful because prices are set by the business whereas changes in
income are beyond the control of the business
...


Q2a ON 2015
A study estimates that dark chocolate has a PED of -0
...
4
...
[8] 5/8
Price elasticity of demand measures the sensitivity of demand to a change in price
...
Based on the question, all chocolates have negative price elasticity of demand
...

Knowledge of price elasticity of demand is useful to businesses because it will help in the formulation of pricing
policies
...
Thus, when
demand is price elastic, a business will be able to increase its total revenue by reducing prices as demand will
increase more than proportionately to the reduction in the price
...
4
being a value greater than -1
...

When demand is price inelastic, consumers are less responsive to price changes and as such an increase in price will
lead to a less than proportionate fall in quantity demanded and hence a rise in total revenue
...
The dark chocolate carries an
inelastic value, -0
...
As such, the chocolate producer should increase the price of the
dark chocolate in order to increase total revenue
...


Q4a MJ 2013
Explain the meaning of ‘protection’ in the context of internaiton trade and describe 2 methods of protection used
by governments
...
They are referred to as expenditure switching policies in that they aim to switch both domestic
and foreign expenditure to the output of goods and services of the domestic economy
...

Tariff is a tax on imports or exports
...
The purposes of imposing tax on exports are to raise
government’s revenue and to increase supply of the product in the domestic market
...
As such, protectionism can safeguard employment rate in the home economy
...
Besides, protectionism can be used to prevent the import of demerit
goods
...
Protectionism take account of
externalities and help deal with such goods through the imposition of high tariffs
...
This increases the supply of a country’s exports in the
world market which will reduce the price below the free market price
...
Gainers are domestic producers when they experience a fall in
cost of production and consumers
...

Export subsidies can be used to safeguard infant (sunrise) industries which have a low output and a high average
cost
...

In addition, protectionism can correct balance of payments disequilibria
...
A government may impose tariff to encourage consumers to switch from
imports towards domestic goods
...
Export subsidies, on the other hand,
lower the exported goods price in the market and increase its competitiveness in world trade
...
[8] 6/8
Private goods are goods that exhibit the characteristics of excludability, diminishing and are rejectable
...
Private goods are also diminishing in the sense that once an individual or firm purchases a private good,
there will be less of the good for others to purchase
...
Rejectability on the other hand refers
to the fact that consumers can refuse the purchase and the consumption of a product
...

Public goods are goods which have the characteristics of being non-excludable, non-diminishing and non-rejectable
...
For example, once national defence has been provided, the society of the country cannot be prevented
from enjoying the security that it provides
...
For instance, once a street light has been installed on a street, the fact
that one individual is utilising the light will not mean there is less light for others to consume
...
For example, the society cannot refuse the protection
which they receive from the police
...
Thus, public goods will not be provided in a free market situation and society
welfare will not be maximised unless the government intervenes to provide then
...


PYQ
Discuss the view that a market economy is always preferable to a planned economy because of the existence of
the price mechanism
...
Consumers will be motivated to maximise their utility and producers are
motivated by profits which will act as an incentive for them to reduce costs and be innovative
...
There are however instance where the market economy fails and government intervention is
required to ensure an optimal allocation of resources
...
These
agencies will determine what is to be produced, the chosen method of production as well as how the goods and
services are to be distributed
...
This
sometimes distorts market forces and worsens the problem of scarcity
...

In a market economy, consumer sovereignty dominates
...
The fact that producers in a market economy will be motivated by profit maximisation would
mean that the method of production chosen will be the least cost method
...
An externality is said to arise if a third party is affected by the decisions and actions of others
...

When positive externalities are present, the market economy will under produce and the government may need to
intervene to ensure higher quantities are produced and consumed
...
In a situation where negative externalities are
present, the market economy will over produce and the government will need to intervene to ensure lower
quantities is produced and consumed
...

The price mechanism causes non-provision of public goods
...
Examples of such goods include street lamps and
national defence
...
No one is
willing to pay for these goods in the free market because they will hope that someone else will
...

In conclusion, a market economy is always preferable to a planned economy because of the existence of the price
mechanism
...


Q3b MJ 2004
Discuss the usefulness to businesses of a knowledge of price elasticity of demand and income elasticity of demand
...
There are
three types of elasticity of demand, which are price elasticity of demand (PED), income elasticity of demand (YED)
and cross elasticity of demand (XED)
...
Normal goods have negative
price elasticity, as in when the price goes up, the quantity demanded fall
...

PED is useful to a business to determine pricing policy
...
If the good is price elastic, businessmen
should decrease the price of the good
...
For example, branded clothes are price elastic goods
...
As an increase in price causes a small decrease in quantity
demanded, the total revenue will increase
...
If the good is unitary elastic,
the businessmen should maintain the price as the total revenue will remain constant although price changes
...
However, if a firm wishes to split the market up into
different segments and charge different prices, it must have a mechanism for keeping the markets separate
...
One of the
application of price discrimination policy is through direct segmentation
...
These businesses will group
customers into few categories such as Child, Adult, Senior Citizen, Local and Foreigner
...

Moreover, PED is useful to the businessmen whether the taxation is able to pass on some or all of the tax onto the
consumer
...
If the consumer is responsive to the
price rise, and PED is elastic, the tax burden will fall mainly on the producers
...
Some retailers are willing to absorb some amount
of the taxation as they fear they would lose sales
...
Normal goods have positive
YED whereas inferior goods have negative YED
...

YED is useful for businessmen to respond to changing economic situations
...
During economic growth, the firms selling normal
goods and luxury goods, such as Nike, Adidas and Chanel, should increase their production because the income of
labours mainly increased
...
Hence, the firms
should focus on producing inferior goods such as basic necessities like bread and rice, as this ensures business
survival
...
By depending upon the YED, the
firms can plan on its diversification activities
...
This saves the company a lot of money by preventing overproduction or underproduction of particular
model
...
During
economic growth, the businesses which produce normal goods and luxury goods should increase their production
and stocking, whereas during recession, they should reduce their production and stocking but the businesses which
produce inferior goods may increase their production and stocking
...
AirAsia can use the YED to determine if they should increase the number of
flights per day
...

In conclusion, knowledge of PED and YED are very useful in businesses
...
Nevertheless, there are also some limitations of elasticity as price and income are not the only
determinants
...


Q3b ON 2013
Discuss whether it would be better if smoking were banned completely or whether it should be subject to an
indirect tax
...
Demerit goods are often
overproduced in the free market situation because of the lack of information about the harmful effects of such
goods
...
Hence, we shall determine if smoking were banned completely or subject to an
indirect tax would be better
...
The most common bans are those that prevent
people from smoking in public areas, but there are certain countries that have put a total tobacco ban in place
...

The advantages of smoking bans are improve national health level
...
The bans also help smokers
in the sense that they reduce their chances of getting ill
...

Besides, smoking bans decrease the possibility of fires
...
By following smoking bans, people can reduce the risks of fire in places with highly flammable materials
...

On the other hand, the disadvantages of smoking bans are cause unemployment
...
Some may lose their job while some may earn much lesser than they used to
...
Smokers may feel offended as smoking is not a crime
...
This may further leads to black markets where the illegal trades
of cigarettes happen
...

However, some may suggest that smoking should be subject to an indirect tax
...
As smoking is tax heavily, it contributes a lot to the country’s economy
...

Furthermore, indirect tax on smoking can reduce the production and consumption of cigarettes
...
Hence, the smokers will reduce their demand towards cigarette smoking as
they could not afford that much
...

As such, indirect tax can minimise negative externalities such as air pollution too
...

For example, negative externality is air pollution due to cigarette smoking
...
The tax revenue collected need to be sufficient to
pay the cost of improving the quality of the polluted air to the quality before externality arise
...
As
cigarette smoking is addictive in nature, the demand is inelastic
...
Soon, when they got sick, they also need to fork out a large amount of money to cure the illnesses
occurred by smoking
...
Majority of the people
would be benefitted as they can live in a healthier and safety environment
...


Q4b MJ 2012
Discuss whether restrictions on international trade can ever be justified
...
For examples, tariffs, quotas, voluntary export restraints where two countries make an
agreement to limit the volume of their exports to one another over an agreed period of time and the most extreme
and hostile one is embargos which is a total ban on imported goods
...
It occurs when there are no
barriers
...
However, restrictions on international trade can be justified
...
If the amount of imported
goods is not restricted, domestic firms may be hard to compete and maintain their sales, hence they may need to lay
off workers or even closed down completely
...

Besides, protectionism is to correct balance of payments disequilibria
...
There is a danger of leading to
retaliatory action by another country
...

Moreover, restrictions on international trade are to safeguard infant (sunrise) industries
...
Trade restriction can be justified if the infant industries possess a potential
comparative advantage and to develop into a profitable business once trade barriers are removed
...

Furthermore, protectionism is to prevent dumping which means the process of selling goods in an overseas market
at a price below the cost of production
...
Foreign firms practice dumping by covering losses
with supernormal profits in order to drive out domestic firms
...

In the longer-term, persistent undercutting of domestic prices can force a domestic industry out of business and
allow the foreign firm to establish itself as a monopoly
...
Therefore protection, via tariffs on 'dumped' goods can be justified to
prevent the long-term exploitation of the consumer
...
For examples, drugs,
tobacco and alcohol which have adverse social effects
...
For example, Bhutan has
banned smoking completely
...
Government
may wish to protect strategic industries, although value judgments will play a role in this in determining what

constitutes ‘strategic industries’
...

In conclusion, protectionism measures have its benefits and disadvantages
...
The more developed
countries use of protectionism will impact the less developed countries as they will be unable to access to the global
market, which prevent their further development
...

[12] 7/12
The fundamental economic problem is ‘scarce resources in relation to unlimited wants’
...
Market economy is a capitalistic economic system in which
there is free competition and prices are determined by the interaction of supply and demand
...

In a market economy, consumer sovereignty exists
...
If consumers, on mass, stop buying a certain product, then the producers would stop making it
...
It makes sense that
allocative and productive efficiency will occur
...

Producers are motivated by the aim of profit maximisation and they will choose the least cost method as method of
production
...
Hence, the free
market maximises community surplus if there are no failures or imperfections
...

In a command economy, the government dominate economic activity
...
The main purpose of government is to maximise public welfare
...
The planners are less likely to make the correct decisions across the whole country
...
The
planners will be happy as long as essential goods are sufficient throughout the country
...
This may worsen the problem of scarcity
...
It can be
concluded that the market economy does solve the problem of scarcity more effectively than the command
economy
...


Q2a MJ 2008
Explain the three economic questions that all economies face because of the basic economic problem
...
Scarcity is a situation in which wants and needs are in excess of the resources available
...

The three economic questions that all economies face are:
-

What to produce?
How to produce?
For whom to produce?

The first question is concerned with product mix
...
In a market
economy, this decision will be based on the interaction of demand and supply and goods will be produced based on
consumer demand
...
This involves making decisions on the methods which are to be employed to
carry out the production for the goods which the economies have decided to produce
...
The
obvious choice in a market economy will be the method which minimizes the cost of production while delivering the
required level of quality
...
Having produced the goods and services, economies will have to find a
mechanism to distribute it to consumers
...


Q2a MJ 2012
Explain why all types of economic system benefit from the existence and use of money
...
In free
market, the decisions on how resources are allocated are based on the interaction of demand and supply
...
In planned economy, the government has a central role in all decisions that are
made whereas in mixed economy, the producers and consumers have sovereignty but may be limited through
government intervention
...

Since the creation of money, all the economic systems need not practice barter system
...
This often leads to the problem of double coincidence of wants as two parties need to have the same
interests in order to exchange
...
It was much more practical compared to barter in all types
of economic system
...
Money has four functions which overcomes the
shortcomings of barter trade
...
It enables people to sell products
and then use the money received to purchase other products, thus overcoming the problem of barter trade, which is
the double coincidence of wants
...
For example, in barter trade, if a person needs coffee in exchange of tea, then he or she
must search for a person who is ready to trade coffee for tea
...
This concerns money’s ability to allow people to lend
and to borrow
...

Credit can now be introduced since there is a standard by which future transactions can be measured against
...

Moreover, money functions as unit of account
...
It allows for different values to be added, measured and compared
...
89 while Pepsi costs $0
...
Thus, customers can compare products' prices easily
...

Lastly, money functions as store of wealth
...
As long as
a currency is not experiencing rapid inflation, holding wealth in money form allows us to delay purchases for a sunny
or rainy day
...


Q3b ON 2015
Discuss whether money is able to perform all its functions effectively in an economy that is experiencing a high
rate of inflation
...
Money can take various forms which
include cash, cheques, credit and debit cards, bank deposits and also e-money
...

Firstly, money functions as medium of exchange
...

This often leads to problems since this is not always present and thus a potential exchange may not occur
...

Besides, money functions as standard for deferred payment
...
Specialisation and exchange would now become common and can extend to the international level
...
Again,
it helps to make contracts which involve future payments
...
It is a ‘unit’ by which prices are established for current and projected
transactions
...
For example, a two-liter of CocaCola costs $0
...
99
...
Due to this, the likely
effects of the introduction of money into a system which uses barter would be that trade would now be easier,
quicker and more widespread since money is now an intermediary and thus, coincidence of wants is no longer a
necessity for exchange
...
It can be held or ‘stored’ for a period of time before it is used
...
The currencies are now in coins and paper notes, making money in convenient denominations, solves
the barter’s problem of absence or lack of divisibility
...
Monetary inflation occurs
when the growth of money supply is greater than the increase in the level of output in a country
...
This is because
inflationary noise will make it difficult to assess what is happening to the price of goods and services
...

If an economy is experiencing a high rate of inflation which is also known as hyperinflation, people may lose
confidence in money and tend to move back to the barter system
...
Large amounts of currency will need to change hands for relatively small transactions
...
Money may not function properly as standard for
deferred payment
...
The banks are unsure about their profit through providing loan services for individuals such as personal loan,
housing loan and car loan
...
The higher the inflation rate, the greater will be the decline in
the value of money
...
Under such
circumstances, people may resort to the use of other mediums such as precious metals like gold as a store of value
...


In conclusion, money is not able to perform all of its functions properly in an economy experiencing a high rate of
inflation
...
The individuals and their daily life will also be
affected due to the limited role of money and hyperinflation
...
[8]
(a) The elasticity of demand for a good is a measure of the degree of responsiveness of the quantity demanded
or the demand to a change in a determinant of demand, ceteris paribus
...

There are different definitions and formulas for PED, YED and XED
...

Mathematically, it can be expressed as
% Δ Quantity Demanded
PED = ————————————% Δ Price
The YED for a good is a measure of the degree of responsiveness of the demand to a change in income, ceteris
paribus
...
Suppose that the two goods are
good A and good B
...
The PED for a good is negative
due to the law of demand and the common practice among economists is to drop the negative sign
...
If the PED for a good is
less than one, such as in the case of food, the demand is price inelastic, which means that a change in the price
will lead to a smaller percentage change in the quantity demanded
...
However, in the cases of YED and XED, they
look at whether the values are positive or negative
...
A normal good with a YED greater than one is known as a luxury and a normal good with a YED less

than one is known as a necessity
...
While
YED distinguishes between normal goods and inferior goods, XED distinguishes between substitutes and
complements
...
If the XEDAB is negative, such as in
the case of car and petrol, good A and good B are complements, which means that the two goods are consumed
together
...
The PED for a good will be higher the larger the
number of substitutes, the closer the substitutes, the lower the degree of necessity, the larger the proportion of
income spent on the good and the longer the time period under consideration
...
The YED for a good will be higher the more luxurious the good and the lower the level of income
...
The XED between two goods will be higher the more closely they are related
...

In conclusion, PED, YED and XED differ in terms of their definitions, formulas, determinants and the
implications of their values
...
[12]
The usefulness of the concepts of elasticity of demand to a firm that produces a fashionable product can be
discussed in terms of how they can aid the firm in making pricing and capacity decisions with reference to price
elasticity of demand, cross elasticity of demand and income elasticity of demand
...

The concept of PED allows a firm that produces smartphones to determine how to change the price to
increase the total revenue
...

Therefore, the firm can decrease the price to increase total revenue as the quantity demanded will rise by a larger
percentage
...
Area C is the gain in revenue resulting from the increase in the quantity demanded (Q) from Q 0 to Q1 and
area A is the loss in revenue resulting from the fall in the price (P) from P0 to P1
...
However, if the firm has no or little excess
capacity or if rival firms follow suit in order to avoid losing sales to the first firm, a fall in its price may not lead
to an increase in its total revenue
...
For example, Apple’s smartphones have voice recognition and fingerprint-password
authentication features which many other smartphones do not include
...

In the above diagram, the initial total revenue is area B plus area C and the new total revenue is area A plus area
B
...
Since area A is greater than
area C, the gain exceeds the loss and hence the total revenue rises
...
For example, in addition to smartphones, Apple Corporation
also sells applications for its smartphones
...
If a rival firm decreases its price, the demand for the
smartphones produced by the first firm will fall due to the positive XED between substitutes
...
However, if this is likely to lead to a price war, the firm
may consider engaging in non-price competition such as product promotion and product development instead
of decreasing its price
...
However, the firm may not experience an increase in sales if it has
no or little excess capacity
...
The YED for smartphones is positive which means
that they are a normal good
...
Furthermore, the higher the
YED is, the larger will be the increase in the demand and hence the larger the extent the firm should increase its
production capacity
...

The concepts of elasticity of demand may not be useful to a firm that produces smartphones as they
are subject to several limitations
...
Data from past records may no longer be relevant to calculating elasticities of demand as some of
the determinants of demand may have changed
...
Furthermore, if the sample sizes of the market surveys are small, the results may not be reliable as
they may not be reflective of the actual markets for the goods
...
In reality, many factors such as the level of
income, the price of the good and the prices of related goods are changing simultaneously
...
For
example, if demand is price elastic, a fall in price will lead to a larger proportionate increase in quantity
demanded resulting in an increase in total revenue
...

PED and XED do not take production capacity into consideration
...

However, total revenue will not rise if there is no excess capacity to increase production
...
In other words, unlike the use of PED which does not have a precondition, the use of YED and
XED requires a change in consumers’ income and the price of a related good respectively
...
However, if the firm
also sells a complementary good such as applications for the smartphones, XED can also be useful for making
proactive business decisions
...
For example, if the firm wants to increase sales revenue due to factors such as it being the key
performance indicator of the management, PED is likely to be useful
...
In this case, PED is
likely to be of limited use to the firm
...

Introduction-Define all key terms: merit goods and demerit goods
...
Merit goods would be
therefore be under – provided in a pure free – market economy
...

Merit goods generate substantial positive externalities and confer benefits on society in excess of the
benefits conferred on individual consumers; in other words, there is a divergence between private and social
costs and benefits, as the social benefits accruing to society as a whole from the consumption of such goods
tend to be greater than the private benefits to the individual
...
The problem is that
individual consumers and producers make their decisions on the basis of their own, internal costs and benefits,
but, from the standpoint of the welfare of society at large, externalities must be considered
...
Indeed, a
major reason for the relatively weak economic performance of many of the poorer countries of the world is the
widespread incidence of ill-health and disease amongst their populations
...
Individuals clearly derive
private benefits from higher levels of education as, for example, earning capacity is to a considerable extent a
function of educational attainment
...
Society also benefits in less tangible ways as it could be argued that educated people are less prone to
crime and racial intolerance, although this argument is obviously not foolproof!
The important point then is that if people had to pay privately through the market for such merit goods
as health and education they would consider only their private benefits and their private costs and would thus
consume too little from the point of view of the best interests of society as a whole
...

Demerit goods are goods which have negative externalities resulting from their consumption
...
Demerit goods are also deemed to be socially undesirable, and which are likely to be over-

produced and over-consumed through the market mechanism
...

Smoking causes additional health cost (external costs) that are paid by the rest of the population
...

The problem arises from the fact that so long as an effective demand is present, such goods are, in all
probability, going to be extremely profitable to produce, and this is all that a price system takes into account –
the market neither possesses a ‘heart’ to enable it to help those in need, nor is it inherently able to make value
judgements about which commodities are good or bad for society as a whole: it is prices and profits which act as
the ‘guiding light’ to resource allocation
...
Thus, the price that consumers pay for a packet of cigarettes is
not related to the social costs to which they give rise i
...
the marginal social cost will exceed the market price and
overproduction and over-consumption will occur, causing a misallocation of society’s scarce resources
...


Diagrams:

Q3b ON 2012
Discuss whether the effect of the rate of inflation on the exchange rate is more or less important than
the effect of the exchange rate on the rate of inflation
...

There are a few causes of inflation such as monetary, cost-push, demand-pull, wage price spiral and multicausal
...
There are a few types of
exchange rates such as nominal, trade-weighted and real effective
...
High inflation will also reduce international confidence in the currency and this will subsequently
affect the foreign direct investment (FDI) and financial flows into the country as investors become vary of
making financial losses following a fall in the external value of the currency
...
However, if a country is experiencing a low and stable rate of inflation, it may not have a noticeable
effect on the exchange rate
...
If the country is operating a floating exchange rate, the domestic value of the currency
will depreciate if inflation is relatively high
...
However, if the high inflation persists, the government may run out foreign reserves as it will
have continually increase demand for its currency to offset the increasing supply
...
A
depreciating exchange rate will make imported factor inputs more expensive (cost-push inflation) and
increase demand for cheaper exports (demand-pull inflation)
...

The impact of changes in the exchange rate on inflation is highly dependable on the extent of the change in
the exchange rate as well as the price elasticity of demand for exports and imports and the citizens’
propensity to import goods and services
...
If a country’s citizens have a high propensity to
import, depreciation in the exchange rate may not reduce the import demand to a large extent as
inflationary pressure will still persist
...
As to which of the two that
carries a greater importance, this will depend on many factors and various conditions that leads to changes
in the inflation and the exchange rate of the country
...
[8] 6/8
A free trade area, customs union and economic union are examples of economic integration that using to
different extent
...
This is where a group of countries decide to abolish trade
barriers between themselves in order to take advantage of the benefits of free trade such as economies of
scale, increasing efficiency and higher level of consumptions
...
However, members are free to determine their own external trade policy
towards non-members
...
NAFTA created a trilateral
trade bloc between Canada, Mexico and USA, whereas ASEAN comprises ten South East Asia countries
namely Malaysia, Singapore, Thailand and others
...
Trade
diversion occurs when trade from outside the group is replaced by trade from within
...
Example of customs union is Gulf Cooperation Council (GCC),
which its member states are Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates
...
If it
wishes to create individual trade deals with, say the USA and China, it cannot retain its current status as a
full member of the customs union
...
It aims at major
integration and often extends to include common external tariffs, free movement of factors of production,
a common economic policy and taxes and a single currency that can be used throughout its member
countries
...
Most members in EU have adopted the euro as standard currency and the
European Central Bank operates a single interest rate
...
Discuss whether it is the case that
specialization and trade will always benefit both countries
...

Product
Switzerland (Number of hours)
Chocolate
1
Textile
2
Table 1: Switzerland and Tunisia Labour Requirements for Production

Tunisia (Number of hours)
10
10

From Table 1, Switzerland is absolutely more efficient in both products
...
Thus, Tunisia has a comparative
advantage in the production of textile where it is less efficient and Switzerland has a comparative advantage in the
production of chocolate
...
If half of the labour hours are put into the production of each product, the resulting output will be
as follow:
Product
Switzerland
Tunisia
Chocolate
30
20
Textile
15
20
Table 2: Balanced Production in Each Country (Without Trade)

Total
50
35

If each country specializes in producing the good which it has a comparative advantage, the resulting output will be
as follow:
Product
Switzerland
Tunisia
Chocolate
60 (30 x 2)
0
Textile
0
40 (20 x 2)
Table 3: Specialisation in Production (with international trade)

Total
60
40

The outcome is that by specializing on the good with the greatest relative efficiency, total output can be increased
...

Domestic opportunity cost ratios must be taken into account to determine if specialization and trade benefit both
countries
...
It is
mutually beneficial to have trades take place between the domestic opportunity cost ratios of the trading partners
...
For example, the assumption of trade involves two countries and two goods
...
It may be
difficult to determine where a country’s comparative advantage lies
...
In reality, transport charges may offset the comparative advantage
...

Moreover, this theory does not take into account of trade barriers which may be present in international trade
...

In conclusion, where there are specialisation and trade, both countries will gain
...
While comparative advantage does improve understanding on international trade
patterns, it fails to take into account many factors which often apply in reality

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