Welcome! In our Economics lesson today, we will be treating these terms under international trade, ” the principles of comparative cost advantage, absolute advantage, terms of trade, and export promotion. Do have a pleasant moment studying with us.

Lesson Note

Subject: Economics

Topic: Overview On Principles of Comparative Cost Advantage And Absolute Advantage, Terms Of Trade, Export Promotion.

Learning Objectives: By the end of the lesson, the learners should be able to:

  1. State the principles of comparative cost advantage;
  2. State the advantages of gain from comparative cost advantage;
  3. What are the limitations of comparative cost advantage?
  4. Explain the principles of absolute advantage;
  5. Define terms of trade;
  6. State reasons for worsening terms of trade in west Africa;
  7. Suggest ways of improving terms of trade;
  8. define export promotion;
  9. State the measures government has taken towards export promotion;
  10. State the reasons for high volume of trade between west African countries and developed countries;
  11. Identify the economic problems associated with dependence of west African countries on primary production.


The Principle of Comparative (cost) Advantage

The principle or theory of comparative cost advantage was propounded by David Ricardo in the 19th century. The theory or principle of comparative cost advantage states that countries derive mutual benefit from trade when they specialise in the production of those commodities in which they have greatest comparative cost advantage over others and exchange them for other commodities which have comparative cost disadvantage.
A country should produce for export those commodities it can produce more cheaply and import those which it can only produce at higher costs. In discussing the principles, absolute advantage is not dealt with, rather, comparative advantage is made use of.
A country has a comparative advantage over others in the production of a commodity in which it has the lower opportunity cost than others. Therefore, it is the real cost of producing a commodity ( in terms of other commodities forgone) that is taken into consideration.

Assumptions Of The Principle Of Comparative Cost Advantage

This principle of theory is based on the following assumptions:
i. There are only two countries.
ii. Only two items are produced with the available resources.
iii. There is free flow and mobility of factors of production.
iv. There is no transport cost.
v. Constant costs prevail.
vi. Technology is constant
vii. Labour is the only factor of production.
In relation to the above assumptions, Nigeria and the United States of America (USA) for example, are producing and consuming rice and wheat. The pre-specialisation production position is shown in schedule A below:

Advantages Or Gains Of Comparative Cost Advantages

i. There is an increase in total world production.
ii. There is better and effective utilisation of resources.
iii. There is increased consumption of commodities e.g rice and wheat.
iv. There are innovations, resourcefulness and improved technology.
v. There is increasing in interdependence between nations of the world.
vi. There is reduction in the prices of goods due to mass production.

Limitations Of The Comparative Cost Advantage

i. There are more than two commodities in the world. The presence of many commodities makes the principle impracticable.
ii. There are also more than two countries in the world.
iii. All countries of the world do not have equal efficiency of labour, not to talk of other factors of production.
iv. There is no free transport between the countries of the world.
v. There are other factors of production other than labour e.g capital, land and entrepreneur.
vi. All countries of the world can never have equal availability of labour.
vii. The cost of production in the world can never be constant.
viii. Trade imbalance between countries of the world also makes the principle unworkable.

The Principles of Absolute Advantage

The principles of absolute advantage was propounded by Adam Smith and it states that a country should specialise in the production of a commodity or commodities and services in which it has absolute advantage over other countries.
According to Adam Smith, a country has an absolute advantage over other countries if she can produce a commodity or service which other countries cannot produce. Again, given the same unit of resources, a country has absolute advantages where she can produce the two commodities concerned at the least cost.

Terms of Trade

Terms of trade may be defined as the rate at which a country’s exports exchange for its imports. It is expressed as a relationship between the prices a country receives for its exports and the prices it pays for imports. In other words, terms of trade is the price ratio between exports and imports. Terms of trade is usually measured by the mathematical formula below;
Terms of trade = index of export price × 100
Index of import price 1
A country’s terms of trade are said to improve when this ratio increases and to worsen when it decreases. The terms of trade are favourable if the average price of exports is higher than the average price of imports. Exports become relatively more expensive than imports. The index of terms of trade would therefore be more than 100. If the prices of exports rise in relation to the prices of imports, the terms of trade will improve, since a given quantity of exports will pay for more imports. Favourable terms of trade leads to a rise in the real national income.
The terms of trade are unfavourable if the average import price is higher than the average export price, which results in more expensive imports than exports and this situation worsen terms of trade. When terms of trade are unfavourable, the index would be less than 100 and this reduces the real national income.

Terms Of Trade In West Africa

Terms of trade in West African countries have been witnessing an unfavourable or worsening trend because the prices of their imports have been increasing relative to prices of exports.

Reasons For The Worsening Terms Of Trade Include:

i. Most West African countries are producers and exporters of primary products e.g agricultural produce and crude minerals.
ii. They Import lots of capital goods in an effort to industrialise thereby increasing imports more than exports.

iii. There has been a fall in the demand for certain primary products of West African countries.This is due to the development of substitutes by the developed nations. This leads to a decision in the price of export and increase in prices of imports.
iv. The production of low quality of manufactured products is also a problem. This is due to low level of technological development. The importation of high quality manufactured products, therefore increases importation over exportation.

How To Improve Terms Of Trade

The terms of trade can be improved by any method which will increase the price of exports relative to imports. These methods include:
i. Use of inflationary policy
ii. Appreciation of the currency
iii. Imposition of higher export duties on commodities with an inelastic demand.
iv. A reduction in the demand for imports.
v. Through collection bargaining, developing countries could achieve higher prices for their exports.
vi. Improvement on the quality of manufactured goods.
vii. There should be increased internal use of primary products in production.

Export Promotion

Export promotion also called export drive may be defined as any policy by which government encourages producers of export goods to produce and export more in order to earn more foreign exchange.

Measures Taken By Government Towards Export Promotion

i. Reduction of export duties: Export can be promoted by reducing export duties.
ii. Subsidy for export based industries: The cost of producing export commodities by export based industries can be subsidised.
iii. Granting of tax incentives: Tax incentives can be given to export based industries.
iv. Setting up of export promotion agencies: Export promotion agencies to encourage exporters can be set up, e.g export processing zone (EPZ) in Calabar.
v. Infrastructural development: Infrastructural facilities like seaports, airports, communication, etc should be developed so as to facilitate or promote exportation of goods.
vi. Reduction of free rate: Freight rate on exports can be reduced to encourage exporters.
vii. Granting of Credit facilities: Credit facilities can be granted or offered to exporters in order to promote export.
viii. Devaluation of local currency: The local currency can be devalued to make export cheaper.

Reasons For High Volume Of Trade Between West African Countries And Developed Countries

The bulk of West African foreign trade is directed away from Africa to the developed countries like Europe and America for the following reasons:
i. Presence of processing industries: Industries that make use of the raw materials which are the main products of West African countries are found in Europe and America.
ii. Absence of developed markets: There is absence of developed markets in Africa because our system of exchange is still underdeveloped and there is low demand as a result of low per capital income.
iii. Over reliance on foreign products: Over reliance on foreign products has made West Africans to have the notion that foreign products are superior.
iv. Low level of technology: Low level of technological development makes it difficult for African countries to produce goods needed in the continent, hence our going to Europe and America.
v. Production of mainly agricultural products: African countries produce mainly agricultural products and this makes exchange of goods between them very difficult.
vi. Provision of capital goods are mainly from developed nations: Capital goods which West African countries depend heavily on are mainly produced in Europe and America.

Economic Problems Associated With Dependence Of West African Countries On Primary Production

i. The development of substitutes
ii. The type of weather in West Africa makes it difficult for them to shift the focus of their production.
iii. West African countries may be forced to depend solely on imported capital and semi-finished goods.
iv. Diversification of the economy becomes difficult because of competition from foreign countries.
v. Difficulties in developing new markets.
vi. The reliance on primary production can cause over-production hence a fall in price.
vii. The terms of trade will deteriorate drastically.
viii. Vulnerability to world recession and price fluctuations.

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Take a quick test for this lesson!

  1. State the principles of comparative cost advantage;
  2. State the advantages of gain from comparative cost advantage;
  3. Explain the principles of absolute advantage;
  4. Define terms of trade;
  5. State reasons for worsening terms of trade in west Africa;
  6. Suggest ways of improving terms of trade;
  7. define export promotion;
  8. State the measures government has taken towards export promotion;
  9. State the reasons for high volume of trade between west African countries and developed countries;
  10. Identify the economic problems associated with dependence of west African countries on primary production.

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