Question

1. According to David Ricardo, what is the role of trade in the wealth of nations? Present his argument.

2a. What determines S? Explain what S depends on.Why would a firm want to know S? Explain how a firm uses S.

2b. What determines AVC? Explain what AVC depends on.Why would a firm want to know AVC? Explain how a firm uses AVC.

Answer 1

1) David Recardo, also known as "the father of free trade". According to him a country can enhance its standard of living and level of consumption by carrying out trade with other countries and producing goods on which it gets a comparative advantage. He believed that the practice of international trade and commerce can increase the wealth of the nations involved in it, by creating more production opportunities, innovations and industrialization.

The Recardian model of international trade depicted that each and every nation can reap benefits from trading the particular commodities in which it has speacilization and comparative advantage over other nations. The theory also focused on the efficiency and productivity of the labour force which he considered immobile among nations but mobile among industries within a nation. He chose to measure all the production cost of a nation in terms of labour only.

2) In economics, the letter S determines Savings, done by an individual or a firm for future financial security and plans. Generally, savings of a person depends on his income and his level of consumption and spendings. He spends his income while consuming different goods and services and whatever is left at the end is considered as his savings. Also, savings can further increase a person's income by putting it as investment in shares, mutual funds, real estate, gold etc,.

A firm would want to the savings of a person as it will depict his capacity to invest. Like if a firm wants to start a new production line, it might issue bonds and stocks for savers as to increase their financial assets. Therefore, the firm would be interested to know the savings of the lenders, who will be buying its stocks and bonds.

3) The term AVC determines the Average Variable Cost in terms of production. It represents variable cost per unit of output produced. It is derived by dividing the total variable cost by the number of units of output produced - AVC = TVC/Q

TVC = Total Variable Cost - is the cost incurred on the employment of variable factors of production whose amount can be altered whenever required in the short-run.

Q = Quantity produced

A firm would want to know the Average Variable Cost as to know its maximum production limit and occurrence of increasing returns till the time AVC is falling. As the returns start to diminish gradually and the AVC increases the firm will stop its production there.