International Trade

This article discusses international trade, absolute advantage, comparative advantage, production possibilities, and equilibrium price ratio. It explains how trade can benefit both countries and increase their consumption possibilities. The article provides detailed calculations and graphs to illustrate the concepts.

Running Head: INTERNATIONAL TRADE
International Trade
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1INTERNATIONAL TRADE
Table of Contents
Answer 1..........................................................................................................................................2
Answer a......................................................................................................................................2
Answer b......................................................................................................................................2
Answer c......................................................................................................................................2
Answer 2..........................................................................................................................................3
Answer a......................................................................................................................................3
Answer b......................................................................................................................................4
Answer c......................................................................................................................................4
Answer 3........................................................................................................................................10
Answer a....................................................................................................................................10
Answer b....................................................................................................................................10
Answer c....................................................................................................................................13
Answer d....................................................................................................................................13
Answer e....................................................................................................................................14
List of References..........................................................................................................................15

2INTERNATIONAL TRADE
Answer 1
Answer a
In Home country, labor hours employed to produce 1 unit of butter is 1/5 hours. The
Foreign country needs to use 1 hours to produce the same. Home country has an absolute
advantage in butter as it can produce it with a less labor hours compared to Foreign (Costinot et
al., 2015). In Home country, 1 hours of labor is used to produce 1 unit cloth. In Foreign, 1/3
hours of labor is used to produce every unit of cloth. Foreign country has an absolute advantage
in producing cloth because of requirement of less labor hours.
Answer b
In Home, unit butter production require 1/5 hours of labor. 5 unit of butter in the Home
county requires (1/5 * 5) = 1 hour of labor. Unit cloth production in Home requires 1 hour of
labor. 3 unit of cloth in Foreign country requires (1*3) = 3 hours of labor. Trading 5 units of
butter for 3 units of cloth Home thus can save (3 – 1) = 2 hours of labor. Using this excess labor
hours Home can produce additional butter (Levchenko & Zhang, 2016). Producing 3 units of
cloth requires (1/3 *3) = 1 hours of labor in Foreign. Producing 5 units of butter requires (1*5) =
5 hours of labor. Trading 3 units of cloth for 5 units of butter leads to saving of (5 – 1) = 4 hours
of labor. The additional labor hours in Foreign could be used to produce more cloths
Answer c
5 unit of butter in the Home county requires (1/5 * 5) = 1 hour of labor. 6 unit of cloth in
Home country requires (1*6) = 6 hours of labor. Trading 5 units of butter for 3 units of cloth
Home thus can save (6 – 1) = 5hours of labor. Producing 5 units of butter requires (1*5) = 5

3INTERNATIONAL TRADE
hours of labor. Producing 6 units of cloth requires (1/3 *6) = 2 hours of labor in Foreign. Trading
3 units of cloth for 5 units of butter leads to saving of (5 – 2) = 3 hours of labor.
Answer 2
Answer a
Figure 1: Production Possibilities (Home)

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Figure 2: Production Possibilities (Foreign)
Answer b
Given that, 5 hours of labor is necessary to produce 1 Motorbike and that of 2 hours of
labor is necessary to produce 1 Skateboard, the relative price of Motorbikes to Skateboard is
PM
PS
= aLM
aLS
¿ 5
2
¿ 2.5
In Foreign, the relative price ratio of Motorbike to Skateboard is
( PM
PS )¿
= aLM
¿
aLS
¿
¿ 3
3
¿ 1
Answer c
After trade, each nation specializes and produces goods in favor of comparative
advantage. As country focuses on production of only one specialized good, resources are utilized
in better way as compared to autarky position where countries need to distribute the available
resources among all the goods (Borkakoti, 2017). As each nation produces only specialized
goods, a large amount of goods is produced with available resources. The increased range of
production expands the choice of consumption as well.

5INTERNATIONAL TRADE
Home uses 5 hours of labor to produce 1 motorbike and it uses 2 hours of labor to
produce1 skateboard. The production of 1 motorbike thus requires sacrifice of (5/2) = 2.5
Skateboards. The opportunity cost of Motorbike relative to Skateboard in Home thus is 2.5 of
Skateboard. Foreign uses 3 hours of labor to produce 1 motorbike and it uses 3 hours of labor to
produce1 skateboard. The production of 1 motorbike thus requires sacrifice of (3/3) =
1Skateboards. In Foreign the opportunity cost of Motorbikes in terms of Skateboard is 1
Skateboard (Chacholiades, 2017). Foreign has a smaller opportunity cost for production of
Motorbike and hence, enjoys a comparative advantage in Motorbike. The opportunity cost of
Skateboard in Home equals (2/5) = 0.4 Motorbikes. The same in Foreign equals (3/3) = 1
Motorbike. In case of Skateboard, Home has a lower opportunity cost and hence, has a
comparative advantage in Skateboard.
After trade Home country would specialize in producing Skateboard while foreign
country would specialize in Motorbikes. In Home country, the relative price of Skateboard in
terms of Motorbike is the opportunity cost of Skateboard that is (2/5). In Foreign country,
relative price of Skateboard to Motorbike is (3/3) = 1. In the world market, the relative price of
Skateboard must be between the ratios of relative prices in the two nation (French, 2016). Under
free trade, relative price of Skateboard to Motorbike is given as 4/5. The given world relative
price is within relative price ratios under autarky in Home and Foreign. Each nation thus would
produce goods in line with the comparative advantage.
In the Home country, available total labor hours is 1000 hours. The maximum labor hours
that Home country could utilize thus is LH = 1000. Home requires 2 hours of labor to produce 1
Skateboard. The unit labor requirement thus is aLS = 2 hours. Using all the endowed labor hours
Home thus is able to produce a total

6INTERNATIONAL TRADE
S= LH
aLS
¿ 1000
2
¿ 500 Skateboard
The relative price of Skateboard in world market is given as 4/5. Following the world
relative price,
1 Skateboard is traded for 4/5 Motorbikes. Therefore, Home can exchange 500 Skateboard for
(4/5 * 500) = 400 Motorbikes.
Before trade, Home needs to produce both Motorbike and Skateboard (Laursen, 2015). The
available labor hours are thus divided between Skateboard and Motorbikes.
aLM M +aLS S=LH
¿ , 5 M+2 S=1000
If Home produces only Motorbikes, then maximum number of produced Motorbike would be
200
If Home produces only Skateboard, then maximum number of produced Motorbike would be
500
After trade, given the world relative price ratio, Home can trade 500 Skateboards in exchange
of 400 Skateboard. The available Motorbikes for consumption in Home country after trade thus
increases from 200 to 400 Motorbikes (Dix‐Carneiro, 2014). The figure below shows the
consumption possibility frontier for Home country before and after trade.

7INTERNATIONAL TRADE
Figure 3: Consumption Possibilities in Home
In Foreign country, available total labor hours is 1200 hours. The maximum labor hours
that Home country could utilize thus is LH = 1200. Foreign requires 3 hours of labor to produce 1
Motorbike. The unit labor requirement thus is aLM* = 3 hours. Using all the endowed labor hours
Foreign thus is able to produce a total
S= LH
aLM
¿
¿ 1200
3
¿ 400 Motorbikes
The relative price of Skateboard in world market is given as 4/5. Following the world
relative price,

8INTERNATIONAL TRADE
1 Motorbike is traded for 5/4 Skateboard. Therefore, Foreign can exchange 400 Motorbikes for
(5/4 * 400) = 500 Skateboard.
Before trade, Home needs to produce both Motorbike and Skateboard. The available labor hours
are thus divided between Skateboard and Motorbikes.
aLM
¿ M +aLS
¿ S=LH
¿ , 3 M +3 S=1200
If Foreign produces only Motorbikes, then maximum number of produced Motorbike would be
400
If Foreign produces only Skateboard, then maximum number of produced Motorbike would be
400
After trade, given the world relative price ratio, Foreign can trade 400 Motorbikes in exchange
of 500 Skateboard. The available Skateboard for consumption in foreign country after trade thus
increases from 400 to 500 Skateboard (Cosar & Fajgelbaum, 2016). The figure below shows the
consumption possibility frontier for foreign country before and after trade.

9INTERNATIONAL TRADE
Figure 4: Consumption Possibilities in Foreign

10INTERNATIONAL TRADE
Answer 3
Answer a
A country enjoys an absolute advantage if it is capable of producing a good at a lower
absolute cost in relation to other country. In H, 1 unit of X is produced using 6 labor. The amount
of labor employed in F to produce 1 unit of X 4. One country conquers an absolute advantage
over another nation if it requires fewer resources in unit production of the good (Watson, 2017).
The country F here requires fewer labor (4 < 6) to produce 1 unit of X. The economy of F is thus
identified as to have an absolute advantage in producing X. 1 unit of Y production in the country
H demands 12 units of labor. The same in the country F demands 2 units’ labor. In case of Y
again, F needs a lesser labor hours compared to H. F thus has an absolute advantage in Y.
Consequently, F has an absolute advantage in making both X and Y.
One country has a comparative advantage over other it production of the specific goods
has a relatively lower opportunity cost to other (Jaimovich & Merella, 2015). In the country H,
Unit production of X needs 6 labors while unit production of Y needs 12 labors. The opportunity
cost of X in H thus equals (6/12) = ½ unit of Y. That is to produce 1 unit of X, H needs to forgo
½ unit of Y. In F, 1-unit production of X needs 4 unit of labor while 1 unit of Y needs 2 unit of
labor. The opportunity cost of 1 unit of X in F equals (4/2) = 2 unit of Y. The relatively low
opportunity cost in for X in H indicates the country has a comparative advantage in X. In
country H, producing 1 unit of Y requires to forgo (12/6) = 2 units of X. In F, production of 1
unit of Y requires to forgo (2/4) = ½ unit of X. In F thus opportunity cost of Y is lower compared
to that in country H. Hence, F has a comparative advantage in making Y.
Answer b

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The total available labors in country H is 2400 units. Country H requires 6 units of labor
to produce 1 unit of X. Therefore, if country H produces only labor then it can produce a total of
(2400/6) = 400 units of X. 1 unit of Y production in H requires 12 labors. Hence, if H produces
only Y, then it is able to produce a total of (2400/12) = 200 units of Y. The production possibility
frontier for economy H is thus bounded by the maximum production of X and Y (Krugman,
Obstfeld & Melitz, 2015).
Figure 5: Production Possibility (H)
Country F in total has 1800 units of labor. Country F employs 4 units of labor to produce
1 unit of X. Therefore, if country F produces only labor then it can produce a total of (1800/4) =
450 units of X. 1 unit of Y production in F requires 2 labors. Hence, if F produces only Y, then it
is able to produce a total of (1800/2) = 900 units of Y. The production possibility frontier for
economy F is thus bounded by the maximum production of X and Y.

12INTERNATIONAL TRADE
Figure 5: Production Possibility (F)
In the absence of trade, the relative price of the goods in each country is same as the
opportunity cost of making the good. This is because, in autarky equilibrium arises at the point
where cost of producing good equals to the purchasing cost of the same.
Equilibrium price ratio is autarky in the country H is determined as
PX
PY
= 6
12
¿ 1
2
¿ 0.5
In the country F, the autarky equilibrium price ratio is computed as
( PX
PY )¿
= 4
2

13INTERNATIONAL TRADE
¿ 2
Answer c
The standard trade theory suggests that for trade to occur, the relative price in the
international market should be between the relative prices of the goods without trade (Gandolfo,
2014). The autarky relative price of X in H is obtained as ½. The relative price of X in F is
obtained as 2. The world price thus should be in between ½ and 2.
The range of feasible equilibrium world price ratios is given as
( PX
PY ) < ( PX
PY )
W
< ( PX
PY ) ¿
1
2 < ( PX
PY )W
<2
Answer d
Country F has an absolute advantage in making both X and Y. The theory of absolute
advantage thus fails to predict any pattern of trade between H and F. Direction of trade is thus
determined following the theory of comparative advantage. The comparative advantage theory
determines the trade pattern depending on the opportunity cost of production (Holmes &
Stevens, 2014). The opportunity cost of X in country H is equivalent to ½ unit of Y. In country
F, the opportunity cost of production of X equals 2 units of Y. Country H thus requires to
sacrifice lesser unit of Y to produce 1 unit of X. Country H thus enjoys an comparative
advantage in producing X. Following the theory of comparative advantage, a country should
specialize and export good with lower opportunity cost (Uhlig, 2017). Country H thus should
export X as it has a comparative advantage in X.

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Answer e
The Ricardian model of comparative advantage, with zero transportation cost and
absence of tariff, prices of output are equalized. Wages which is the return to labor are not
equalized. Return to labor reflects the productivity of labor. As productivity differs between the
two trading nations, wages are not equalized. Trade increases price of the exported goods raising
wages in sectors producing the exportable good. It does not however equalize wage among
trading nations. Price at equilibrium is determined from the world relative supply and world
relative demand (Baier, Bergstrand & Feng, 2014). Since, factor price are not determined by
relative demand and relative supply, they are not equalized.
In each nation wage is equivalent to the labor productivity. The assumption of perfect
competition implies that Pi = ACi, where i denotes positive output (Burstein & Vogel, 2017). In
the given example, H specializes in X while F specializes in Y. Suppose, wage in the country H
is denoted as w and that in F is given as w*.
PX =aLX ×w
¿ aLX w
PY∗¿ aLY
¿ × w∗¿
¿ aLY
¿ w∗¿
W
W∗¿= PX
PY∗¿ × aLY
¿
aLX
¿
¿
≠ 1¿

15INTERNATIONAL TRADE
List of References
Baier, S. L., Bergstrand, J. H., & Feng, M. (2014). Economic integration agreements and the
margins of international trade. Journal of International Economics, 93(2), 339-350.
Borkakoti, J. (2017). International trade: causes and consequences. Macmillan International
Higher Education.
Burstein, A., & Vogel, J. (2017). International trade, technology, and the skill premium. Journal
of Political Economy, 125(5), 1356-1412.
Chacholiades, M. (2017). The pure theory of international trade. Routledge.
Cosar, A. K., & Fajgelbaum, P. D. (2016). Internal geography, international trade, and regional
specialization. American Economic Journal: Microeconomics, 8(1), 24-56.
Costinot, A., Donaldson, D., Vogel, J., & Werning, I. (2015). Comparative advantage and
optimal trade policy. The Quarterly Journal of Economics, 130(2), 659-702.
Dix‐Carneiro, R. (2014). Trade liberalization and labor market dynamics. Econometrica, 82(3),
825-885.
French, S. (2016). The composition of trade flows and the aggregate effects of trade
barriers. Journal of international Economics, 98, 114-137.
Gandolfo, G. (2014). International Trade and Growth: Dynamics. In International Trade Theory
and Policy (pp. 321-327). Springer, Berlin, Heidelberg.
Holmes, T. J., & Stevens, J. J. (2014). An alternative theory of the plant size distribution, with
geography and intra-and international trade. Journal of Political Economy, 122(2), 369-
421.

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Jaimovich, E., & Merella, V. (2015). Love for quality, comparative advantage, and
trade. Journal of International Economics, 97(2), 376-391.
Krugman, P., Obstfeld, M., & Melitz, M. (2015). International Trade: Theory and Policy:
Global Edition. Pearson Higher Ed.
Laursen, K. (2015). Revealed comparative advantage and the alternatives as measures of
international specialization. Eurasian Business Review, 5(1), 99-115.
Levchenko, A. A., & Zhang, J. (2016). The evolution of comparative advantage: Measurement
and welfare implications. Journal of Monetary Economics, 78, 96-111.
Uhlig, H. (2017). Business Cycles and International Trade. Journal of Political
Economy, 125(6), 1761-1766.
Watson, M. (2017). Historicising Ricardo’s comparative advantage theory, challenging the
normative foundations of liberal International Political Economy. New Political
Economy, 22(3), 257-272.