WAEC SSCE - Economics - 2020

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A country should embark on development planning to ensure that its scarce productive resources are efficiently utilized. Development planning helps a country to identify its available resources and allocate them in a way that maximizes their impact on economic growth and social welfare. This can help the country to achieve its development goals, such as reducing poverty and inequality, improving education and healthcare, and creating job opportunities. Furthermore, when a country efficiently utilizes its resources, it is likely to attract foreign investment, which can lead to greater economic growth and development. By contributing its own quota to international organizations, a country can also enhance its global reputation and play a more active role in addressing global issues.

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The correct answer is "joint supply." When an increase in the production of beef leads to an increase in the supply of hides, it means that the two products are produced together as part of the same process. In other words, the production of one good generates the production of the other good as a byproduct. This is known as joint supply. Therefore, when there is an increase in the supply of beef, there will automatically be an increase in the supply of hides as well, and vice versa. This is because both goods are produced together and cannot be easily separated. It's important to note that joint supply is different from competitive supply, where two or more goods are produced using the same resources and compete for those resources. Joint supply is also different from composite supply, where two or more goods are combined to create a new product. Finally, joint demand refers to two or more goods that are demanded together, such as cars and gasoline.

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Dumping refers to the practice of selling goods in a foreign market at a price that is below what is sold in the home market. This means that the price of the goods in the foreign market is lower than what consumers would pay if they were buying the same goods in the country where the goods were produced. This practice is often used to gain a competitive advantage in a foreign market by undercutting the prices of local producers, which can lead to increased market share and profits for the exporter. However, dumping can also be considered a form of unfair trade practice, as it can harm local industries and disrupt the market by artificially lowering prices.

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The central bank can reduce the ability of commercial banks to give out loans in a few ways, but one simple way is by raising the bank rates. When the central bank raises the interest rates, it becomes more expensive for commercial banks to borrow money from the central bank. Consequently, the commercial banks will also increase the interest rates for their customers to make up for the extra cost of borrowing from the central bank. As a result, fewer people and businesses will want to borrow money, which means that the commercial banks will give out fewer loans. Another way the central bank can reduce the ability of commercial banks to give out loans is by reducing the special deposits. When the central bank reduces the special deposits that commercial banks have to keep with them, the banks will have less money to lend out to their customers, which means that they will give out fewer loans. Similarly, the central bank can also reduce the liquidity ratio, which is the percentage of the commercial banks' assets that they have to keep as liquid cash. When the central bank reduces the liquidity ratio, the banks will have to keep less money as liquid cash, which means that they will have less money to lend out to their customers. Issuing more currency, on the other hand, can actually increase the amount of money that commercial banks have available to lend out. Therefore, it would not reduce the ability of commercial banks to give out loans.

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NNP at factor cost is derived from GNP at market prices by adjusting for the difference between market prices and factor costs, which is represented by indirect taxes and subsidies. Factor costs refer to the actual cost of producing goods and services, including wages, rent, and interest, while market prices include indirect taxes such as sales tax, excise tax, and customs duty, as well as subsidies, which are payments made by the government to reduce the cost of production or consumption. To calculate NNP at factor cost, we need to subtract the indirect taxes and add the subsidies from GNP at market prices, since these adjustments represent the difference between market prices and factor costs. We also need to subtract depreciation, which refers to the wear and tear of fixed assets over time, to arrive at NNP, which represents the net value of goods and services produced in the economy. Therefore, the correct formula to calculate NNP at factor cost is: NNP at factor cost = GNP at market prices - Depreciation - Indirect taxes + Subsidies

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The exploitation of mineral resources is a form of primary production. Primary production refers to the extraction and harvesting of raw materials from natural resources, such as agriculture, forestry, fishing, and mining. In the case of mineral resources, primary production involves the extraction of minerals from the ground or from ore deposits using various techniques, such as drilling, blasting, and excavation. Secondary production, on the other hand, refers to the transformation of raw materials into finished products through manufacturing processes. For example, turning iron ore into steel, or refining crude oil into gasoline. Tertiary production is the provision of services, such as healthcare, education, finance, and transportation. Therefore, since the exploitation of mineral resources involves the extraction of raw materials from the ground, it falls under the category of primary production.

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The principle of comparative advantage encourages a country to engage in trade if it can produce a commodity at a lower cost. The principle of comparative advantage is an economic theory that suggests that countries should specialize in producing goods or services that they can produce at a lower cost than other countries. By doing so, they can trade their specialized goods with other countries for goods that are produced more efficiently by other countries. In simpler terms, the principle of comparative advantage encourages countries to focus on what they do best and trade with other countries for the things they don't do as well. For example, if Country A is better at producing computers than Country B, and Country B is better at producing cars than Country A, then it makes sense for Country A to focus on producing computers and trade with Country B for cars, and for Country B to focus on producing cars and trade with Country A for computers. Therefore, the principle of comparative advantage encourages countries to engage in trade if they can produce a commodity at a lower cost than other countries, rather than trying to be self-sufficient or specializing in the production of all goods.

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A large firm may experience diseconomies of scale if there is difficulty in coordinating decisions. This means that as a company grows and becomes larger, it may become harder for the management to make decisions that will benefit the entire company as a whole. This can happen because there are more people involved in the decision-making process, and it may be difficult to get everyone on the same page. Additionally, as a company grows, it may become more difficult to communicate effectively with everyone in the organization, leading to a breakdown in coordination and increased inefficiencies.

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The unit price of the firm's output can be found by dividing the total revenue by the number of units sold. For example, when the firm sells 50 units, the unit price is $85 / 50 = $1.70. Similarly, the unit price remains constant at $1.70 for all other outputs. So the answer is $1.70.

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The change in demand from D\(_{1}\)D\(_{1}\) to D\(_{2}\)D\(_{2}\) is caused by a rise in the price of a substitute for commodity X. When the price of a substitute for commodity X increases, consumers tend to switch to commodity X, resulting in an increase in demand for commodity X. Therefore, the demand curve for commodity X shifts to the right from D\(_{1}\)D\(_{1}\) to D\(_{2}\)D\(_{2}\). It is important to note that since commodity X is a normal good, a fall in the income of consumers would cause a leftward shift of the demand curve, not a rightward shift. A rise in the price of a complement or a fall in the supply of commodity X would result in a leftward shift of the demand curve for commodity X.

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Increasing returns to scale suggests that a firm can make more profit by increasing output. This means that if a firm increases all of its inputs, such as labor and capital, by a certain percentage, the output will increase by an even greater percentage. In other words, the firm becomes more efficient as it produces more, resulting in lower costs per unit of output and greater profits. This concept is opposite to the concept of decreasing returns to scale, where increasing all inputs leads to a proportionately smaller increase in output.

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Tools of monetary policy refer to the methods that central banks use to influence the supply of money and credit in an economy. The main tools of monetary policy are open market operations, reserve requirements, and bank rates. Open market operations involve the buying and selling of government securities by the central bank to influence the amount of money in circulation. When the central bank buys government securities, it injects money into the economy, and when it sells them, it takes money out of the economy. Reserve requirements refer to the amount of money that banks are required to hold in reserve, either with the central bank or in their own vaults, to ensure that they have enough funds to meet their obligations to depositors. Bank rates refer to the interest rate that the central bank charges on loans to commercial banks, which can influence the interest rates that banks charge to their customers. Tax and public expenditure policies are not tools of monetary policy. Tax policies refer to the way that governments collect revenue from individuals and businesses, while public expenditure refers to the way that governments spend money on public goods and services. These policies are typically set by government authorities, not central banks, and are used to achieve broader economic goals, such as promoting economic growth or redistributing wealth.

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Expenditure on food takes a large proportion of the incomes of people in developing countries. This is because in these countries, people have lower incomes and a higher cost of living, which means they have to spend a larger portion of their income on necessities like food. Additionally, there may be limited access to affordable, nutritious food options, which can further drive up the cost of feeding a family. In contrast, in industrialized or advanced countries, people generally have higher incomes and a lower cost of living, so they are able to spend a smaller portion of their income on food.

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The location of iron and steel industry at a place is primarily due to easy access to raw materials, particularly iron ore and coal. Iron and steel production require large quantities of these materials, and so industries tend to locate near areas where these resources are readily available. Other factors such as access to cheap labour, good infrastructure, and government policies may also play a role, but they are not as significant as the availability of raw materials. Access to cheap labour can reduce production costs, while good infrastructure can make transportation of raw materials and finished products easier. Government policies such as tax incentives and subsidies may also attract industries to certain locations. Overall, the availability of raw materials is the most important factor in determining the location of iron and steel industry.

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The feature of the average fixed cost is that it falls continuously but is never equal to zero. This means that as the quantity of production increases, the average fixed cost per unit decreases, but it never reaches zero. This is because fixed costs, such as rent and equipment, are spread out over a larger quantity of goods, resulting in a lower cost per unit. However, even if the quantity of production is zero, fixed costs still exist, so the average fixed cost cannot be zero.

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The concept that is central to the definition of economics is "scarcity." Scarcity refers to the limited availability of resources (such as time, money, land, and natural resources) relative to unlimited human wants and needs. In other words, there are never enough resources to satisfy all of our wants and needs, which creates the need for choices and trade-offs. Economics is the study of how individuals, businesses, governments, and societies allocate scarce resources to satisfy their unlimited wants and needs. It examines how people make decisions in the face of scarcity, how they interact with one another in markets, and how policies can be designed to improve societal well-being given the constraints imposed by scarcity. Understanding scarcity is essential to understanding economics, as it explains why we make choices and trade-offs in our daily lives, why markets exist, and why governments intervene in those markets.

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Import substitution is a strategy of industrialization that involves developing locally produced goods as replacements for imported ones. The idea is to decrease a country's dependence on imported goods and increase local production, which can lead to economic growth and development. This strategy involves creating and supporting industries that can produce goods locally that were previously imported, thereby reducing the amount of money that leaves the country for imports. It also helps to create jobs, increase the number of businesses in the country, and build the country's manufacturing capabilities. Therefore, the correct option is "development of locally produced goods as replacements for imported ones."

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Based on the information you have provided, it appears that the system of taxation employed is a progressive tax system. In a progressive tax system, the tax rate increases as the amount of income increases. This means that those who earn more pay a higher percentage of their income in taxes compared to those who earn less. In this case, Mrs. Y pays a higher amount of taxes compared to Mr. X even though they both earn different amounts of money. This is because Mrs. Y earns more and is therefore taxed at a higher rate. In summary, the progressive tax system is a tax system that takes a larger percentage of income from those who earn more, in order to provide services and benefits to the public.

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The statement describes a "quota". A quota is a restriction on the quantity of a certain good that can be imported or exported during a specified period. In this case, the country is allowed to import only 50,000 tonnes of rice annually, meaning that the country's government has set a limit on the amount of rice that can be imported into the country each year. The purpose of the quota could be to protect domestic producers from foreign competition, to manage the supply of the product in the market, or to regulate the price of the commodity.

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The function of the wholesaler that enables him to stabilize prices is warehousing goods. This means that the wholesaler stores a large quantity of goods in a warehouse and releases them in the market as and when needed. This helps in avoiding price fluctuations caused by shortages and surpluses in the market. By having a large stock of goods, the wholesaler can ensure a steady supply of products to retailers, which helps in maintaining stable prices.

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In a free market economy, resources are allocated through the price mechanism. This means that the prices of goods and services, and the demand for those goods and services, determine how resources are used and distributed. For example, if there is a high demand for a certain product, the price for that product will increase and producers will allocate more resources to producing that product. Conversely, if demand for a product decreases, the price will decrease and producers will allocate fewer resources to producing it. The price mechanism helps to ensure that resources are allocated in the most efficient and effective way possible, based on the wants and needs of consumers.

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Of the options listed, illiteracy is likely to have the least effect on agricultural productivity in West Africa. Illiteracy refers to the inability to read or write, and while it can be a barrier to accessing information and education, it is not directly related to agricultural productivity. Farmers can still have knowledge of traditional farming methods and local environmental conditions without being able to read or write. In addition, there are many extension services and NGOs working to provide education and training to farmers in West Africa, which can help to overcome the challenges posed by illiteracy. On the other hand, the incidence of pests and diseases, unfavorable weather conditions, and urban-rural migration are all major challenges that can significantly impact agricultural productivity in West Africa. Pests and diseases can destroy crops and reduce yields, unfavorable weather conditions such as droughts and floods can damage crops and cause food shortages, and urban-rural migration can reduce the labor force available for farming and lead to the abandonment of farmland. Therefore, while illiteracy remains a significant issue in West Africa, it is likely to have the least effect on agricultural productivity compared to the other options listed.

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Money would cease to be a good store of value when prices of goods and services are rising rapidly. This is because when prices rise quickly, the value of money decreases over time, and people can buy fewer goods and services with the same amount of money. As a result, people may look for alternative stores of value, such as real estate, gold, or other assets that retain their value better than cash. In contrast, when prices are falling slowly or rising slowly, money can still maintain its value as a store of value because its purchasing power remains relatively stable. However, high levels of unemployment can also affect the value of money as it reduces the amount of income and spending power in the economy, leading to lower demand for goods and services, which may result in deflation.

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Labor productivity is a measure of how much output is produced by a worker in a given period of time, usually an hour. It is calculated by dividing the amount of output produced by the number of hours worked. In other words, labor productivity is a measure of how efficient a worker is at producing goods or services. Therefore, the correct option is "output per man-hour".

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A consumer is in equilibrium when he or she maximizes his or her satisfaction from spending his or her income. This means that the consumer has allocated his or her budget in a way that gives him or her the highest level of satisfaction possible. At this point, the consumer has no desire to change his or her spending choices because any alteration would result in a lower level of satisfaction.

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Goods are described as inferior if their demand decreases as income increases. In other words, when people's income rises, they tend to buy less of these goods and switch to more expensive alternatives. This is because inferior goods are often considered lower quality or less desirable compared to other options available in the market. For example, let's say that someone's income rises and they can now afford to buy more expensive cuts of meat. They may start to buy less ground beef, which is considered an inferior good, and more expensive cuts like steak. This is because they can now afford to buy better quality meat, which they perceive as more desirable. On the other hand, if the price of a good increases, its demand is likely to decrease regardless of whether it is an inferior or a normal good. This is because as the price of a good goes up, people tend to look for cheaper alternatives or reduce their overall consumption of that good.

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An increase in the price of beef from $4.00 per kg to $6.00 per kg may cause a surplus in the market, as producers will likely increase their supply of beef to take advantage of the higher price, while consumers may decrease their demand for beef due to the higher price. This results in a situation where the quantity of beef supplied exceeds the quantity of beef demanded at the new higher price, leading to a surplus. A surplus occurs when there is an excess supply of a product that is not being bought by consumers, and it can result in prices being driven down in the future, as producers look to sell off their excess inventory.

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Price elasticity of supply measures the responsiveness of the quantity supplied of a product to a change in its price. It is calculated by dividing the percentage change in quantity supplied by the percentage change in price. In this case, the seller increased the quantity supplied from 200 units to 250 units when the price increased by 12.5%. We can calculate the percentage change in quantity supplied as follows: Percentage change in quantity supplied = ((new quantity - old quantity) / old quantity) x 100% = ((250 - 200) / 200) x 100% = 25% We can calculate the percentage change in price as follows: Percentage change in price = 12.5% Using these values, we can calculate the price elasticity of supply as: Price elasticity of supply = (percentage change in quantity supplied / percentage change in price) Price elasticity of supply = 25% / 12.5% = 2.00 Therefore, the price elasticity of supply for this product is 2.00, which means that a 1% increase in price leads to a 2% increase in the quantity supplied. This indicates that the supply of this product is relatively elastic, meaning that the seller is responsive to changes in price and is able to increase the quantity supplied significantly when the price increases.

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Land as a factor of production can be made useful through the application of human effort. This includes activities such as farming, construction, and mining, which involve the use of labor and resources to turn the land into a productive asset. For example, a farmer may use their land to grow crops, which can be sold for profit. A construction company may use their land to build houses or other buildings. The application of human effort makes land a valuable resource that can contribute to economic growth and development.

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If a country wants to discourage the importation of manufactured goods, it should adopt an import substitution strategy. This is a policy where a country seeks to replace imported goods with locally produced goods in order to reduce dependency on foreign goods and to promote domestic industries. This can be done by implementing policies that provide incentives for the development of local industries, such as tax breaks or subsidies, and by imposing restrictions or tariffs on imported goods. By doing so, the cost of imported goods becomes higher, making them less attractive and less competitive compared to the locally produced goods. Therefore, the correct option is "import substitution strategy".

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(a) Consumer goods. Consumer goods are goods produced for direct final use and satisfaction by consumers, not for producing other goods. Examples are food, clothing, and a television set used at home. They may be durable (a car) or non-durable (bread).

(b) Forms of capital.

• Fixed capital. Durable producer goods that are used again and again in production over a long period without being used up in a single act of production. Example: machinery, factory buildings, tractors.
• Social capital. Capital assets provided mainly by the government for the benefit of the whole community rather than a single firm; also called social overhead capital or infrastructure. Example: roads, schools, hospitals, water and electricity supply.
• Circulating (working) capital. Capital that is used up or transformed in a single round of production and must be replaced each time. Example: raw materials, fuel, and money for wages.

(c) Three reasons for a low level of savings in a country.

• Low income. Most people earn little and spend nearly all of it on necessities, leaving little to save.
• High propensity to consume / large family size. Heavy consumption needs and dependants reduce what can be set aside.
• Lack of adequate banking and saving facilities, especially in rural areas, so people have few safe places to keep savings.
• Inflation. Rising prices erode the value of money saved and discourage saving.
• Low interest rates offering little reward for saving.

Examination takeaway. Distinguish the three capitals by how they are used: fixed capital lasts through many rounds of production, circulating capital is used up in one round, and social capital is community infrastructure provided mainly by government.

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(a) Subsistence farming vs commercial farming.

(b) Four features of subsistence farming.

• Production is mainly for family consumption, not for sale.
• Small farm size and scattered plots.
• Use of simple, crude tools and traditional methods.
• Reliance on family labour with little hired labour.
• Low yield and little or no surplus for the market.
• Heavy dependence on natural rainfall and little use of modern inputs.

(c) Effects of mining on the economy of West African countries.

Two positive effects:

• Earnings and revenue. Mining (for example crude oil, gold, bauxite) earns foreign exchange and government revenue used for development.
• Employment and infrastructure. It creates jobs and often brings roads, electricity, and towns to mining areas.

Two negative effects:

• Environmental damage. Mining causes land degradation, pollution of water and air, and destruction of farmland.
• Over-dependence on one product. Heavy reliance on a single mineral makes the economy vulnerable to falls in world prices, and it can draw labour away from agriculture.

Examination takeaway. For the comparison in (a) contrast the same feature (purpose, scale, tools, output) on both sides, and in (c) give a balanced answer with clearly separated positive and negative effects as the question demands.

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(a) Money. Money is anything that is generally acceptable as a means of payment for goods and services and in the settlement of debts. Its main functions are to serve as a medium of exchange, a measure (unit) of value, a store of value, and a standard for deferred payments.

(b) Concepts.

• (i) Value of money. The value of money is its purchasing power, that is, the quantity of goods and services a unit of money can buy. It varies inversely with the general price level: when prices rise (inflation) the value of money falls, and when prices fall the value of money rises. \[ \text{Value of money} \propto \frac{1}{\text{Price level}} \]
• (ii) Demand for money. The demand for money (liquidity preference) is the desire to hold wealth in cash or liquid form rather than in other assets. Following Keynes, money is demanded for three motives: the transactions motive (day-to-day spending), the precautionary motive (unforeseen needs), and the speculative motive (to take advantage of changes in interest rates or asset prices).

(c) Four determinants of the transactions demand for money.

• Level of income. The higher a person's or nation's income, the more cash is held for spending.
• The price level. Higher prices require more money to buy the same goods.
• Frequency (interval) of income payment. People paid weekly hold less than those paid monthly, other things equal.
• The general standard of living / spending habits. Higher consumption needs raise the cash held for transactions.
• The value of transactions a person expects to carry out over the period.

Examination takeaway. Keep the two ideas distinct: the value of money is about what money can buy (inverse of prices), while the demand for money is about why people choose to hold cash; the transactions motive in particular depends mainly on income and the price level.

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(a) Competitive demand and joint demand.

• Competitive demand exists when two goods are substitutes, so that they satisfy the same want and compete for the consumer's income. A rise in demand for one reduces demand for the other. Example: butter and margarine, or tea and coffee.
• Joint (complementary) demand exists when two goods are used together to satisfy a want, so that they are demanded jointly. A rise in demand for one raises demand for the other. Example: cars and petrol, or bread and butter.

(b) Effects on the equilibrium price and quantity of commodity R.

• (i) A rise in the price of a complement of R. Because the complement is now dearer, less of it is bought, and since R is used together with it, the demand for R falls. The demand curve for R shifts to the left, lowering both the equilibrium price and the equilibrium quantity of R. On the diagram, show demand shifting left from \(D_1\) to \(D_2\) along the supply curve, giving a lower price and lower quantity.
• (ii) A rise in the price of a substitute of R. The substitute is now dearer, so buyers switch to R; the demand for R rises. The demand curve for R shifts to the right from \(D_1\) to \(D_2\), raising both the equilibrium price and the equilibrium quantity of R.
• (iii) Imposition of an indirect tax on R. The tax raises producers' costs, so supply falls; the supply curve shifts to the left (up) from \(S_1\) to \(S_2\). The equilibrium price rises and the equilibrium quantity falls.

Examination takeaway. A change affecting buyers' willingness (price of a related good) shifts the demand curve, while a change affecting producers' costs (a tax) shifts the supply curve; identify which curve moves before reading off the new price and quantity.

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(a)(i) Capital expenditure and recurrent expenditure.

• Capital expenditure is government spending on durable assets and projects that yield benefits over many years, such as building roads, bridges, schools, and dams. It is non-recurring and adds to the nation's stock of capital.
• Recurrent expenditure is government spending on the day-to-day running of government that recurs regularly, such as salaries of civil servants, maintenance, and consumables. It does not create lasting assets.

(a)(ii) Fiscal policy and monetary policy.

• Fiscal policy is the use of government taxation and public spending (the budget) to influence the level of economic activity. It is operated by the government/treasury.
• Monetary policy is the use of instruments that control the money supply, credit, and interest rates (open-market operations, bank/liquidity ratio, discount rate). It is operated by the central bank.

(b) Four reasons why a government imposes taxes.

• To raise revenue. Taxes finance government spending on public goods and services such as defence, roads, and education.
• To redistribute income. Progressive taxes take more from the rich to fund services and transfers for the poor, reducing inequality.
• To control consumption. Heavy taxes on harmful goods (tobacco, alcohol) discourage their consumption.
• To protect infant/local industries. Import duties make foreign goods dearer and shield domestic producers.
• To manage the economy (stabilisation). Taxes are raised to curb inflation (reduce demand) or lowered to fight unemployment (boost demand).
• To correct a balance of payments deficit by taxing imports.

Examination takeaway. Keep the two policy tools separate by their operator and instrument: fiscal policy is government + budget (tax and spend), monetary policy is central bank + money and credit.

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(a) Completed table

Number of workers	Total product (TP)	Marginal product (MP)	Average product (AP)
0	0	0	0
1	20	20	20
2	50	30	25 (Z)
3	70	20	23.3
4	80	10 (Y)	20
5	80	0	16
6	70.2 (X)	-9.8	11.7

Calculations

\[Z=AP_2=\frac{TP_2}{2}=\frac{50}{2}=25\]

\[Y=MP_4=TP_4-TP_3=80-70=10\]

\[X=TP_6=TP_5+MP_6=80+(-9.8)=70.2\]

Therefore: \(X=70.2\), \(Y=10\), and \(Z=25\).

(b)

1. Increasing returns: from 1 to 2 units of labour, as marginal product rises from 20 to 30.
2. Decreasing returns: from 3 to 4 units of labour, as marginal product falls from 20 to 10 while total product continues to rise.
3. Negative returns: at 6 units of labour, where marginal product is \(-9.8\) and total product falls.

(c) Law of diminishing returns

As successive units of a variable factor are added to fixed factors of production, the marginal product of the variable factor will initially increase, but after a certain point it begins to decline.

(d)(i) Total product and marginal product curves

(d)(ii) Relationships between total product and marginal product

1. When marginal product is positive, total product rises. When marginal product is zero at the fifth worker, total product remains at its maximum level of 80 units.
2. When marginal product becomes negative at the sixth worker, total product falls from 80 units to 70.2 units.

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(a) Tariff. A tariff is a tax or duty imposed on goods that are imported (or sometimes exported) as they cross a country's border. It raises the price of the affected goods and is used to earn revenue and to protect domestic industries.

(b) The two laws.

• (i) Law of absolute cost advantage (Adam Smith). A country should specialise in producing and exporting the commodity that it can produce more cheaply (using fewer resources) than another country, and import the commodity that the other country produces more cheaply. Trade then benefits both because each concentrates on what it makes at lower absolute cost.
• (ii) Law of comparative cost advantage (David Ricardo). Even if one country is more efficient (has an absolute advantage) in producing both goods, mutually beneficial trade is still possible if each country specialises in the good in which it has the lower opportunity cost (its comparative advantage) and trades for the other. Each gains by giving up less of the alternative good.

(c) Four assumptions behind the law of comparative cost advantage.

• There are only two countries producing two commodities (the 2 x 2 model).
• Labour is the only factor of production, and it is homogeneous (labour theory of value).
• Factors are perfectly mobile within each country but immobile between countries.
• There are constant costs / constant returns to scale in production.
• There are no transport costs and no trade barriers (free trade).
• There is full employment of resources and perfect competition.

Examination takeaway. The key difference is that absolute advantage compares actual costs, while comparative advantage compares opportunity costs; comparative advantage is the more powerful law because it shows gains from trade even when one country is better at everything.