WAEC Economics 2012 Theory — Question 3

Model answer

(a) The law of comparative cost advantage states that a country should specialize in the production of the commodity(ies) in which it has a comparative (relative) cost advantage, i.e. where it can produce at a lower opportunity cost relative to other countries, even if it does not have an absolute advantage in producing any commodity. By specializing according to comparative advantage and trading, both countries can gain more than they would through self-sufficiency. (b) Limitations of the law: (i) The theory assumes that there are only two countries and two commodities involved in trade, which is unrealistic in the real world where many countries and commodities are involved. (ii) It assumes that there is no transportation cost between the two countries, which is unrealistic since the cost of moving goods from one country to another is significant and can offset the gains from specialization. (iii) It assumes perfect mobility of factors of production within a country and immobility between countries, which does not always hold. (iv) It ignores the possible effects of economies of scale and technological differences.