Question

3) Would a country with an absolute advantage in the production of all goods and services trade with other countries? Explain. 4) "A shortage is the same thing as scarcity." Do you agree or disagree with this statement? Why? What can cause a shortage to disappear in a market? What can cause scarcity to disappear? 5) Given a market equilibrium point, explain, using the concepts of demand and supply, how it is achieved 6) How is the equilibrium price determined? What happens if the price is above the equilibrium price? What happens if the price is below the equilibrium price?

Answer 1

3. Let us consider this scenario

Countries	Production of Food in units	Production of Clothing in units
United Kingdom	200	500
France	100	200

Assuming same set of resources available UK can produce both Food and Clothing in greater quantities than France.

So it enjoys absolute advantage in production of both the commodities as it can produce both of them efficiently.

Therefore the question is,  should the two countries engage in trade?

Theories of absolute advantage may not say so, but comparative advantage theories as pioneered by Ricardo say yes.

They should trade.

The reason is that in latter theory we make use of concept of opportunity cost.The cost of second best alternative or the cost incurred for foregoing an alternative.

Here the opportunity cost (o.c.) of both countries are calculated as below

Countries	o.c of Clothing	o.c of Food
UK	200/500= 0.4 units of food forgone to produce 1 unit of clothing.	500/200= 2.5 units of clothing forgone to produce 1 unit of food.
France	100/200= 0.5 units of food forgone to produce 1 unit of clothing.	200/100= 2 units of clothing forgone to produce 1 unit of food.

Therefore the opportunity cost of producing food is lower for France than UK. Therefore it should specialize in producing food only and UK should produce clothing. They can enter into international trade and exchange units of goods which other countries produces efficiently.

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4. Shortage and scarcity as understood in economics are two different things.

Shortage may be real or artificially created ( E.g. hoarding ). It refers to the situation where the market does not have enough supply to meet the quantity demanded at required price.

For example, due to frosty weather the wheat production suffers due to which there is a shortage of grains. So in this case the State/Govt. may help clear the market by opening its buffer stock of foodgrains or enter into trade with other countries to supply the net quantity which it cannot produce domestically immediately. Therefore generally shortage is a short term phenomenon which can be addressed through measures taken by the State.

In contrast scarcity of resources means the constraints due to which a country can produce only within its PPF (Production Possibility Frontier). These constraints may arise due to natural, ecological, geographical etc reasons and are sometimes out of the reach of the State to correct.

For example, a region in US which witnesses frequent earthquakes may not produce enough of foodgrains on its own. This is because given its geographical stature there is scarcity of resources to meet its local requirements.

As scarcity is a longer term phenomena policymakers find alternative solutions such as technological advancement to address scarcity issues.

As scarcity cannot be addressed completely in short term horizon so it may not disappear from markets but an effective long term planning is essential here.

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5. In any competitive market , equilibrium is achieved through the forces of supply and demand. If at a particular price the sellers are willing to sell their lot and at the same time buyers are willing to buy the market gets cleared and equilibrium is established.

For example, Suppose a price of a vanilla ice-cream is $2 per cone.So a total of 400 buyers are willing to buy the cone at this price.So quantity demanded is 400 units.

Moreover the sellers of ice-cream are also willing to supply 400 cones at $2.So quantity supplied is 400 units.

As quantity demanded equals quantity supplied therefore the price of an ice-cream cone is established at $2 and markets reach equilibrium.

However if due to any reasons surpluses and shortages are generated which cause disequilibrium, prices would move in either upward or lower direction till the point is reached where the total supply meets the total demand and market gets cleared.

Some theories of market equilibrium (Cobweb Model) talks about time lags in production which causes irregular fluctuations in prices and quantities. Despite these periodic movements the market gets eventually cleared in the form of cobweb and equilibrium is maintained.

Here we assume characteristics of free market mechanism.

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6. As explained above in free markets, equilibrium price is determined through the forces of supply and demand.As put forward by classical economists the invisible hand of market ensures pareto optimal outcomes of production and distribution of economic resources.Here, Prices act as signals to movements in supply and demand and any such movement is well incorporated by such efficient markets.

If prices are above equilibrium point then shortage is generated where supply < demand. So quantity demanded falls as at higher prices buyers would buy less and until it reaches the supply and market equilibrium is restored.

Similarly, when prices are below the equilibrium point then there is surplus generated. Here demand < supply. So at lower prices buyers are willing to buy more, demand rises till it reaches supply and market equilibrium is again restored.

Here it is assumed that it is laissez faire market.

However if there was Govt control on market mechanism, the State would have corrected the market distortions through creating or releasing buffer stocks thereby establishing equilibrium.