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International Trade Assignment 1

Question 1

By the use of example, explain the difference between the Ricardian model and a
specific factor model.

Ricardian model

The focus is on comparative advantage. The model suggests that the countries specialize in
producing goods and services that that they can do best. The model assumes that there is only
one factor of production. The model suggests that the trade occurs between countries because
of the differences in labor productivity that occurs because of technological differences. The
model applies in the short run because the technology can change internationally over time.

It is a model that assumes that there are two countries which is home and foreign, producing
two goods which is for example wine and cheese and using only one factor of production
which is labor. The model is a general equilibrium model in which all markets such as goods
and factors are perfect competition. Labor productivity varies across countries due to
different in technology but labor productivity in each country is constant and the supply of
labor in each country is also constant.

Perfect competition means that many businesses produce output in each industry such that
each firm is too narrow for its output decision to cause the market price. Firms select the
output to maximize profit. The model used by perfect competition firms is to select that
output level which is price equal to marginal cost.

Output is similar across all firms which mean that goods are similar in all of their
characteristics such that a customer would finds goods and services from other firms that are
not identifiable or not distinguish. Free entry and exist of firms in response to profits.

Positive profit which is a surplus sends a signal to the rest of the economy and new firms
enter the industry. Negative firm’s profit which is a deficit leads to existing firms one by one
out of the industry. In a long run economic profit leads to zero in the industry. All firms have
the accurate information to maximize profit and to identify the positive profit (surplus) and
negative profit (deficit) industries.
Examples of relative price of cheese

The Namibian dollar price of wine is N$ 5 per gallon and the Namibian dollar of cheese is N$
20 per pound then the relative price of cheese is 4 gallons of wine per pound of cheese
therefore, the relative price of cheese is the wine equivalent of whatever one pays to buy
cheese.

Examples of relative price of wine

The Namibian dollar price of wine is N$ 5 per gallon and the Namibian dollar price of cheese
is N$ 20 per pound then the relative price of wine is 4 pounds of cheese per gallon of wine
therefore, the relative price of wine is the cheese equivalent of whatever one pays to buy
wine.

Specific factor model

This model allows trade to affect income distribution. This model assumes that an economy
produces two goods (food and cloth) using three factors of production: land labor and
capital. Perfect competition prevails in all markets. Cloth produced using capital and labor
but not capital. Labor is a mobile factor that can move between sectors land and capital are
both specific factor used only in the production of one good.

We further assume that there are two sectors, the food and manufacture sector.

It allows for differences between general purpose factor and specific factors for particulars
use. The economy’s output of manufacture depends on these factor inputs labor and capital
while the economy’s output for food depends on land and labor. The larger the input of labor
for certain supply the larger the output. But if labor forces increase in capital stock there will
be diminishing return.
Question 2

What are the assumptions of the (H-O)?

1. There are 2 countries, 2 alike goods, 2 alike factors of production whose initial levels
are fixed and supposed to be relatively to be different in each country.
2. Technology is similar in both countries and the production function is the similar in
both countries.
3. Production is distinguished by constant returns to scale for both items in both
countries.
4. The two items have different factor intensities and have the same factor price ratios
5. Tastes and preferences are similar in both countries
6. Perfect competition live in both countries
7. Factors are perfectly mobile within each country but not between countries
8. There are no transport costs
9. There are no strategies limiting the movement of goods between countries interfering
with the market determination of prices and output.

Explain how trade under the (H-O) theory affects relative earnings.

Trade produces an intersection of relative prices. Changes in relative prices can affects on the
relative earnings of labor and land.

- An increase in the price of cloth lifts up the purchasing power of labor in terms of
both goods while decreases the purchasing power of land in terms of both goods.
- An increase in the price of food lifts up the purchasing power of land in terms of both
goods, while decreasing the purchasing power of labor in terms of both goods.
- It is for this reason that international trade has a powerful effect on income
distribution.
- In home, where relative prices of cloth increases, people who get income from labor
gain from trade but those who deserve their income from land are made worse off.
- In foreign, where relative prices of cloth fall decreases, people who get income from
labor loose from trade but those who derive their income from land will gain or be
better off.
 - The resource of which a country has a relatively more supply is the plentiful factor
(labor in home, land in foreign), while the resource of which the country has relatively
few supply is a scarce factor.
- The owners of country’s plentiful factors obtain from trade while the owners of a
country with scarce factors lose.

.
Question 3

3.1

Namibian (dollar) Botswana( pulla)

a) What is the opportunity cost of beef (B) and computer chips (C) in each country?

In Namibia the opportunity cost of 1 unit of beef is 2/1= 2 chips and

The opportunity cost of 1chip is ½= 0.5 unit of beef.

In Botswana the opportunity cost of 1 unit of beef is 8/2= 4 chips and

The opportunity cost of 1 chip is 2/8= ¼ unit of beef.

b) In which commodity does the Namibia have a comparative cost advantage? What
about Botswana?

Namibia has a comparative cost advantage in beef with respect to Botswana because its
opportunity cost is less than of Botswana while Botswana has a comparative cost advantage
in computer chips because its opportunity cost is less than of Namibia and Kenya will export
chips to Namibia.

c) What is the range for mutually beneficial trade between Namibia and Botswana for
each computer chip traded?

The range for mutually beneficial trade between Namibia and Botswana for each unit of beef
that Namibia exports is 2C>1B>4C
d) How much would Namibia and Botswana gain if 1 unit of beef is exchanged for 3
chips?

Both Namibia and Botswana would gain I chip for each unit of beef traded. If computer chips
produced by Botswana themselves, they will give up 4 units of beef for every ratio; if they
can trade3 chips they are more in desirable or advantageous position. If Namibia produces
chips themselves, they give up 2 units of beef for every ratio. If they can get 3 chips for 1
ratio they could be more in desirable or in advantageous position also.

3.2. How can we use the production possibility frontier to determine opportunity cost?
Production possibility frontier it is a curve that show the differences in the amounts that can
be produced of two products, if both depend upon similar finite resource for their
manufacture.

Production possibility illustrates the tradeoff between two goods. The slant of the
production possibility frontier is the opportunity cost of the good on the X-axis. The joint of
the slope is the opportunity cost of the good on the Y-axis. Opportunity cost relate to the
shape of production possibility frontier curve. If the form of the production possibility
frontier curve is a straight line, the opportunity cost is unchanged as production of different
goods is changing. Opportunity cost usually differs depending on the starting and ending
points.
Question 4

4.1. What is the Stolper-Samuelson theorem?

a) Provide an intuitive explanation of the theorem.

Stolper-Samuelson theorem assume that if the relative price of a good increases, then the real
wage or rental rate of the factor used intensively in the production of that good increases,
while the real wage or rental rate of the other factor decreases. E.g. an increase in the relative
price of cloth increases the real wage and decreases the rental rate of capital. Any change in
the relative price of goods alters the distribution of income. Stolper-Samuelson theorem can
be explained intuitively as follow: Assume that a single sector manufacture exports and the
other one manufacture goods which compete the same with imports. Assume in addition that
the import sector is relatively labor-intensive this means that it uses a big ratio of labor to
capital than the export sector.

b) When would the theorem be invalid and why?

Stolper-Samuelson theorem may be invalid in a three-factor (land, labor and capital), two-
good model and some scientists have shown that under such settings the Stolper-Samuelson
effect does not necessarily generalize. Specifically, the effect of good price changes in a two-
good, three-factor model and find that under specific technical conditions, an expansion of a
sector may actually imply a fall in the price of its most used factor. The theorem having
predicted that wage inequality should have fallen.
4.2. Inter-Industry Trade is when a country is exporting and importing products that belong
to different industries. It is usually a result of comparative advantage based on differences in
relative factors of production. E.g. the trading of agricultural products produced in one
country with technological equipment produced in another country while Intra-Industry
Trade is when a country is exporting and importing products that belong to the same
industries.it is usually driven by product differentiation and economies of scale.

4.3. Specific Tariff is a tariff stipulated as a money amount per physical unit of import. It is
also a tax that is equal to a fixed amount of money per unit sold while Ad valorem Tariff is a
tariff that is set as a percentage of the value of goods when they reach the importing country.
It is also a tax that is equal to a certain percentage of the good’s selling price.

4.4. Comparative Advantage

It is a concept based on relative costs of production and opportunity cost between nations; on
the other hand it emphasizes differences in international technology/productivity.
Comparatives advantage measures the opportunity cost of producing a good. A country has a
comparative advantage if it can produce a good at a lower opportunity cost than another
country. The concept of comparative advantage can be explained as follow: of the labor
requirement for producing food is lower than that of producing cloth in the same economy
and that means that this country has a comparative advantage in producing food if it can
trade.
References

Centre for External Studies. 2003. International Trade. University of Namibia

https://my.unam.edua.na/module-notes/EIT3771

https://www.cousehero.com/file/p3skrt/heading-trade-based-on-comparative-advantage-
David-ricardo-level-medium-24-who/