International Trade: Comparative Advantage

This solved assignment explores the concept of comparative advantage in international trade. It analyzes a scenario where two countries, Home and Foreign, have different productivities in producing corn and radios. The assignment delves into determining each country's opportunity cost, the terms of trade under free trade, and the impact of specialization on both countries. It utilizes graphical representations to illustrate concepts like relative supply curves, world prices, and consumer equilibrium.

Running Head: INTERNATIONAL TRADE
International Trade
Name of the Student
Name of the University
Course ID

1INTERNATIONAL TRADE
Table of Contents
Answer 1..........................................................................................................................................2
Correlation between Openness and GINI index..........................................................................2
Answer 2..........................................................................................................................................2
Stolper-Samuelson Theorem.......................................................................................................2
Answer 3..........................................................................................................................................5
Answer 4..........................................................................................................................................5
Answer a......................................................................................................................................5
Answer b......................................................................................................................................6
Answer c......................................................................................................................................8
Answer d......................................................................................................................................9
Answer e......................................................................................................................................9
Reference list.................................................................................................................................11

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Answer 1
Correlation between Openness and GINI index
Openness is a measure of countries’ engagement in trade. Openness represents sum of
export and import as a percentage of Gross Domestic Product in a nation. GINI index measures
the prevailing inequality in the nation. The GINI coefficient can be used as a proxy measure of
ratio of skilled to unskilled wage. For Paraguay, the estimated correlation coefficient between
openness and GINI index is -0.26. This implies an inverse relation exists between openness and
GINI index. As participation of the nation in trade, increase the inequality in the nation
decreases. The rising proportionate share of trade in GDP thus is positive contributor to income
equality and living standard. The value of correlation coefficient is small indicating a weak
relationship between openness and GINI for Paraguay. The correlation coefficient for between
the two variables in case of Poland is -0.61. For Poland, also increasing openness reduces the
GINI index. The effect of trade on inequality is however stronger for Paraguay than that for
Poland. That means, that means the increasing openness of Poland has a much stronger effect in
reducing inequality than that for Paraguay. Trade thus has a beneficial impact on economic
development in form of a reduced income inequality.
Answer 2
Stolper-Samuelson Theorem
The Stolper Samuelson theory one of the basic theorem obtained from Heckscher-Ohlin
trade theory. The theory explains relationship between rewards to factor inputs and relative price
for produced output. If relative price in the world market increases, then the factor that is used
intensively in production gains a higher reward (Feenstra, 2015). The theory can be explained

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with help of a hypothetical example. Suppose country A has two substitutable factor input skilled
and unskilled labor. WU/WS represents ratio of relative wages of unskilled labor to skilled labor.
Using the two inputs suppose the country can produce two goods X and Y. For any given WU/WS
, the nation faces a higher cost minimizing input ratio for good X as compared to good Y. This in
turn implies
aSX ( W U
W S )
aUX ( W U
WS )
>
aSY ( W U
W S )
aUY ( WU
W S )
Good X is therefore skill intensive while good Y is unskilled labor intensive. The Zero profit
conditions are obtained as
Zero profit for X
W U aUX
( W U
W S ) +W S aSX
( W U
W S )=PX
Zero profit for Y
W U aUY
( W U
W S )+W S aSY
( W U
W S )=PY

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Figure 1: Free trade and Stolper-Samuelson theory
(Source: as created by Author)
In the above figure the steeper line represents the zero profit line for Y as it in intensive in
unskilled labor. The relatively flatter line shows the same for X. Under autarky equilibrium is at
A. The dotted line shows zero profit line of X under free trade. The equilibrium now moves to
point B. Under free trade as (WS/PY ) increases representing a fall in PY, (WU/PX) falls indicating a
fall in wage of unskilled labors. In order words, a fall in PY/PX raises wage of skilled laborers in
terms of both X and Y. The decline in relative price of unskilled-intensive good hurts unskilled
labor while benefits skilled labors. This explains the Stolper Samuelson theorem.

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Answer 3
The Stolper Samuelson theorem states that an increase in relative price of a good
increases return to the factor that is most intensively used in the production process. Given that,
both the countries are unskilled labor abundant countries, following Heckscher Ohlin theorem
both the countries should specialize in unskilled labor-intensive goods. From Question 1, a
negative correlation is obtained between openness and GINI index. The GINI index can be used
to present ratio to skilled to unskilled wages. The negative correlation indicates that as countries
become more and more open the ratio of skilled to unskilled labor wages falls. In order words, as
the countries engage in trade the unskilled laborers receive a higher relative wage. Both the
countries being unskilled-labor abundant countries must be engaged in exporting unskilled labor-
intensive good. When countries engage in export it receives a higher price in the world market
than that in the home market (Chacholiades, 2017). Therefore, as the country’s export unskilled
labor intensive goods, with an increase in relative price the abundant factors (unskilled laborers)
receives a higher wage and hence GINI index falls. This supports the proposition of Stolper
Samuelson theorem which states that a higher relative price of output means a higher reward
intensive factor.
Answer 4
Answer a
Corn Demand :QD
C = I
3 PC
Radio Demand :QD
R = 2 I
3 PR

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Relative demand for radio=QD
R
QD
C
¿
2 I
3 PR
I
3 PC
¿ 2 I
3 PR
× 3 PC
I
¿ 2
PR
PC
Figure 2: Relative demand curve for Radios
Answer b
Unit of goods produced with
1 unit of labor
Corn (C) Radio (R)
Home 2 3

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Foreign 2 4
Opportunity cost Corn (C) Radio (R)
Home 1.5 0.66
Foreign 2 0.5
Feasible production using all
the factor input
Corn (C) Radio (R)
Home (2*30)= 60 (3*30)= 90
Foreign (2* 60) = 120 (4*60) = 240
Home will produce radio if relative price of radio is greater than the opportunity cost of radio
that is (aLC/aLR) = 0.66. Foreign will produce radio if relative price of radio is greater than the
opportunity cost of radio that is (aLC*/aLR*) = 0.5
The relative quantity of Radio =
QR + QR
¿
QC+ QC
¿
Given Home country specializes in Corn and Foreign Country Specializes in Radio, the relative
quantity can be determined as
240
60 =4

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Figure 3: World relative supply curve
Answer c
QD
R
QD
C = 2
PR
PC
At QD
R
QD
C = 4,
PR
PC
= 2
4 =0.5
The world price under free trade thus equals opportunity cost of radio in foreign.

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Figure 4: Equilibrium price and quantity under free trade
Answer d
Under free trade foreign country produces Radio and Home country produces Corn as the
countries enjoy a comparative advantage in respective product line. Using all its workers, home
country will be able to produce 60 units of corn while foreign country is able to produce 240
units of Radio.
Answer e
Home country will gain from the trade. It will obtain Radio at a price lower than it would
face otherwise.
The foreign country on the other hand remain indifferent between trade and autarky
situation. As world price is exactly same as the opportunity cist faced by the nation, no additional
gain will be enjoyed by the foreign country.

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Figure 5: Benefits to the workers in Home country
The benefit to the labor can be understood from evaluation of consumer equilibrium with
the help to budget line and indifference curve. Before trade, equilibrium for home country’s
worker is at E. After trade because of a lower price of radio the budget line will shift pivotally
towards radios. The new equilibrium is at E1. The workers in home country now consume a
higher radio given corn. The workers in home country also benefitted from a higher wage after
specialization in corn.

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Reference list
Chacholiades, M. (2017). The pure theory of international trade. Routledge.
Feenstra, R. C. (2015). Advanced international trade: theory and evidence. Princeton university
press.