Assignment 1: International Econonmics, Part 1 Write a 4-6 page paper in which you: 1. Explain the concept of comparative advantage and the principle theories of why trade occurs. 2. Analyze and...

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INTERNATIONAL ECONOMICS, PART 1 1
Assignment 1: International Economics, Part 1
Sherman Woodard
ECO 305, International Economics
07/24/2013
Dr. Frances Les
INTERNATIONAL ECONOMICS, PART 1 2
ABSTRACT
The essay attempts to give a rationale for occurrence of trade across countries, based on
the technological differences and varying resource endowments. It finds the explanation deep
into theories of comparative advantage, mainly the famous Ricardian theory and the Heckscher-
Ohlin model. An attempt has been made to explain the imperfections in free trade that
subsequently lead to mobility of factors as well. Also, it analyses various trade policies like
import tariff, non-tariff barriers like import quotas which encourage free trade and some
protectionist trade policies and their impact on welfare of the nation.
Explain the concept of comparative advantage and the principle theories of why trade
occurs.
The world today seeks commendable importance on global international trade among
nations. Over time nations have realized the importance of opening up their economies and went
rigorously into free trade with other countries. The need for trade among countries arises through
a chain of factors, which is represented in the flow chart below.
Heckscher-Ohlin Model
jsjknkxsxnsknof comparative
advantage
Ricardian Theory
TRADE
DIFFERENCE IN PRICES
DIFFERENCE IN SUPPLY AND DEMAND
TECHNOLOGICAL DIFFERENCE RESOURCE ENDOWMENT DIFFERENCES
INTERNATIONAL ECONOMICS, PART 1 3
Behind the evolution of trade is the concept of comparative advantage that can be
explained by two theories: Ricardian theory and Heckscher-Ohlin model.
The theory of comparative advantage was explained by Ricardo where it was first used to
argue against the Corn Laws in USA, and favored free trade and specialization. This theory
states that trade among countries based on the comparative advantage will also benefit the
countries with absolute disadvantage in factors.
It is imperative to understand the fine line of distinction between absolute advantage in
production of a commodity and comparative advantage in production of a commodity for a
country. This can be understood with the help of a hypothetical example. Suppose there are two
countries Argentina and Brazil and both use one factor only, say labor. Both the countries
produce two goods only, Oil and Coffee. The labor requirement for producing oil in Argentina is
3 units of labor and in Brazil is 9 units of labor. The labor requirement for producing coffee in
Argentina is 6 units of labor and in Brazil is 12 units of labor.
Given such a hypothetical situation, the Argentina has absolute advantage in production
of both oil and coffee since its labor requirement is less than that of Brazil in both the goods. But
it must be noted that Brazil has comparative advantage in producing coffee. This is because in
Brazil coffee can be produced by sacrificing only 1.33 units of oil, which is calculated as
follows: number of units of oil produced in Brazil by 1 labor hour is 1/9 and number of units of
coffee produced in Brazil by 1 labor hour is 1/12; so shifting of labor from oil to produce 1 unit
of coffee costs (1/9)/(1/12) = 1.33 units of oil. Similarly for Argentina units of oil produced by 1
labor hour is 1/3 and units of coffee produced by 1 labor hour is 1/6; so shifting of labor from oil
to produce 1 unit of coffee costs (1/3)/(1/6) = 2 units of oil. Hence, Brazil requires fewer
INTERNATIONAL ECONOMICS, PART 1 4
resources to produce coffee relative to oil, and thus, Brazil is said to have comparative advantage
in producing coffee and Argentina is said to have comparative advantage in producing oil.
It is important to note that countries should specialize in the production of the good in
which they possess comparative advantage and free trade shall take place across the two
countries so that they can trade for the good in which they have comparative disadvantage with
the other country in...