Management Notes

Reference Notes for Management

By adjusting the model of comparative advantage to include transportation costs along with production costs we would expect

By adjusting the model of comparative advantage to include transportation costs along with production costs we would expect

 Options:

a. the prices of traded goods to be lower than when there are no transportation costs
b. specialization to stop when the production costs of the trading partners equalize
c. the volume of trade to be less than when there are no transportation costs
d. the gains from trade to be greater than when there are no transportation costs

The Correct Answer Is:

c. the volume of trade to be less than when there are no transportation costs

Correct Answer Explanation: c. the volume of trade to be less than when there are no transportation costs

In the world of international trade, understanding the impact of transportation costs alongside production costs is pivotal. The inclusion of transportation costs in the model of comparative advantage alters the dynamics of trade.

The correct answer, “c. the volume of trade to be less than when there are no transportation costs,” aligns with economic theory and the practical implications of trade adjustments when transportation expenses are factored in.

When transportation costs are considered, they act as a barrier, influencing the flow of goods between trading partners. These costs add to the final price of traded goods.

As a result, some goods that might have been traded profitably without transportation costs now become less attractive due to the additional expenses incurred in shipping or transporting them across borders.

Consequently, the volume of trade decreases because not all goods that were previously economically viable to trade remain so when transportation costs are factored in.

Now, let’s delve into why the other options are not the correct answers:

a. “the prices of traded goods to be lower than when there are no transportation costs”:

When transportation costs are introduced into the equation, they act as an additional expense that gets factored into the final price of traded goods. These costs include expenses related to shipping, handling, tariffs, and various logistical expenses associated with moving goods from one location to another.

Consequently, the inclusion of transportation costs tends to increase the overall price of traded goods rather than lowering them. This is because sellers need to cover these additional expenses, which often get passed on to the consumers in the form of higher prices.

b. “specialization to stop when the production costs of the trading partners equalize”:

The theory of comparative advantage focuses on relative efficiencies rather than absolute cost equalization. Even if production costs between trading partners were to equalize, there’s still room for specialization based on comparative advantage.

Comparative advantage is determined by relative, not absolute, production efficiencies. Therefore, specialization doesn’t necessarily cease when production costs become equal; it’s guided by the principle of producing what a country can produce most efficiently relative to its opportunity cost.

d. “the gains from trade to be greater than when there are no transportation costs”:

While the gains from trade typically arise due to specialization and exploiting differences in comparative advantage, the inclusion of transportation costs can alter this scenario. These additional costs associated with transportation reduce the overall gains from trade.

The expenses incurred in shipping and transporting goods across borders can eat into the potential gains that would have been achieved in a situation where transportation costs weren’t a factor. Therefore, the gains from trade might be reduced due to the added expenses, rather than being greater.

In summary, integrating transportation costs into the model of comparative advantage significantly impacts trade patterns and the economic feasibility of trading specific goods.

While the correct answer anticipates a decrease in the volume of trade due to the limitations imposed by transportation expenses, the other options present inaccurate predictions or misinterpretations of the effects of transportation costs on traded goods, prices, specialization, and overall gains from trade.

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