Economics of International Trade - Assignment Example

Economic of International Trade Name: Institution: Date: Question one a) The labor hours per week in Atlantis are 2000 labor hours while in Lemuria are 3600 labor hours. By considering the table showing the labor hours needed to produce one unit of computers and cloths in each island, another table can be generated that shows the number of computers and cloths produced per week in each Island. In Atlantis the number of computers produced per week are (2000/20)*1=100 computers while the number of cloths produced per week are (2000/10)*1=200 cloths. In Lemuria the number of computers produced per week are (3600/45)*1=80 computers while the number of cloths produced per week are (3600/15)*1= 240 cloths. The above information can be presented in the table as shown Atlantis Lemuria No. of Comp Produced 100 80 No. of Cloths produced 200 240 From the above table it can be observed that Atlantis Island has an absolute advantage in computer production. Lemuria Island on the other hand has absolute advantage in Cloths production. Adam Smith, in his theory of absolute advantage, states that trade occurs among two nations if one nation has an absolute advantage in producing one commodity and the other nation has an absolute advantage in producing another commodity. Therefore, in these two Islands, Atlantis will specialize in computer production in which it has an absolute advantage over Lemuria while Lemuria will specialize in cloths production in which it has an absolute advantage over Atlantis. b) i) Production possibility frontier for Atlantis ii) Production possibility frontier for Lemuria c) In Atlantis the number of labor hours available for clothes production are (½)*2000 labor hours per week and for computer production are (½)*2000 labor hours per week. Similarly, in Lemuria, the labor hours per week available for clothes and computer production are (½)*3600 each. Therefore, in Atlantis the number of computer and clothes produced will be (1000/20)*1=50 and (1000/10)*1=100 respectively. In Lemuria, the number of computer and clothes produced will be (1800/45)*1=40 and (1800/15)*1=120. This information can be shown in the PPF as follows In Atlantis Global production of clothes and computers will be 220 and 90 respectively. d) The opportunity cost of producing one computer in Atlantis is two clothes foregone. In Lemuria, the opportunity cost of producing one computer is three clothes foregone. In Atlantis (hrs. /unit of cloth)/ (hrs. / Unit of comp) = (2000/200)/ (2000/100) = 0.5 In Lemuria (hrs. /unit of cloth)/ (hrs. /unit of comp) = (3600/240)/ (3600/80) =0.33 Since 0.5 is greater than 0.33, it implies that Atlantis has comparative advantage in production of clothes. The pattern of trade will be; Atlantis will specialize in clothes production while Lemuria will specialize in computer production. e) If all resources in Atlantis are directed towards clothes production then 200 units of clothes and 0 units of computers will be produced. In Lemuria, if all resources are directed towards computer production then 0 units of clothes and 80 units of computers will be produced. The global production of clothes and computers will be 200 units and 80units respectively. f) 1 computer=2.5 clothes. For Atlantis 200 Units of clothes= 80 units of computers For Lemuria 80 units of computers=200 units of clothes g) If 50 computers are traded for 125 units of clothes, Atlantians will benefit from trade. Lemurians on the other hand will not benefit from trade. h) Global consumption with trade will be 100 computers and 250 clothes. Global consumption without trade 200 clothes and 80 computers. The gain from trade will be 50 units of clothes and 20 units of computers. Question two a) Australia Demand curve Australia Supply curve New Zealand Demand curve New Zealand supply curve b) Slope of curve is normally given as ∆y/∆x. Therefore, to get the demand function and supply function for Australian goods, it is important to first determine the slopes of the curves. The supply function for Australian goods will be: ∆p/∆q= (45-0)/ (1800-0) = 45/1800= 0.025 Equation of a straight line is normally given as y=a+mx, where m is gradient and a is constant. For this case a is 0, therefore the equation will be p=0.025Qss The demand function will be: ∆p/∆q = (0-45) / (1200-0) = -0.0375. When p=0 and Qdd=1200, a equals 45. The equation of a line therefore becomes p=45-0.0375Qdd At equilibrium, quantity demanded equals quantity supplied. Qss=p/0.025 and Qdd= (45-p)/0.0375 Qdd=Qss= (45-p)/0.0375=p/0.025; p= $18 Qss= 18/0.025= 720 units Qdd= (45-18)/0.0375= 720 units Therefore, the equilibrium price and quantity of calculators in Australia are $18 and 720 units respectively. In New Zealand, the supply function will be: ∆p/∆Q= (0-45)/ (0-1200) = 0.0375 At p=0 and q=0, a=0; the supply function equals to, p=0.0375Qss The demand function will be; ∆p/∆q= (0-45)/ (1800-0) = -0.025 At p=45 and q=0, a=45, the demand function will then be, p=45-0.025Qdd At equilibrium, quantity demanded equals quantity supplied Therefore, (45-p)/0.025= p/0.0375 P= $27 Equilibrium price and quantity of calculators are $27 and 720 units respectively. Australia has a comparative advantage in calculators c) Since Australia has a comparative advantage, it will be willing to export calculators. New Zealand on the other hand will be willing to import calculators. Therefore, using the Australian supply function and New Zealand demand function, the price that bring balance between exports and imports can be found. Australian supply function is p=0.025Qss New Zealand demand function is p=45-0.0375Qdd There is a balance in exports and imports if quantity demanded equals quantity supplied, thus Qss=Qdd=p/0.025= (45-p)/0.025 0.025p= (45*0.025)-0.025p P=$22.5 $22.5 is the price that brings about balance in imports and exports At this price, 900 calculators are traded. With trade, the price of one calculator in Australia is $22.5. The amount of calculator demanded at this price will be Qdd= (45-p)/0.0375 Qdd= (45-22.5)/0.0375= 600 Australia produces 900 calculators and consumes 600 calculators Quantity supplied in New Zealand at P=22.5, will be 22.5/0.0375=600 New Zealand produces 600 calculators and consumes 900 calculators. d) With trade, transportation cost will increase price of calculators in Australia and New Zealand. The price of each calculator with trade is $22.5. If the cost of transporting each calculator is $5, the price of each calculator will increase to $27.5. At a price of $27.5, Australia will produce, Qss= p/0.025=27.5/0.025=1,100 calculators. It will consume Qdd= (45-p)/0.0375= (45-27.5)/0.0375= 467 calculators Australia will therefore trade 1,100-467= 633 caculators New Zealand will produce Qss=27.5/0.0375= 733 calculators It will consume Qdd= (45-27.5)/0.025= 700 New Zealand will trade 733-700= 33 calculators e) The price of traded commodity in each trading country increases with the introduction of transportation costs. Each country tends to specialize more in producing a product. Transportation costs enhance volume of trade. Question three a) Mexico is relatively more labor abundant. This is because the ratio of workers to machines in Mexico is greater than the ratio of workers to machines in United States, that is, For Mexico; 60/10=6 and for United States; 200/40=5. Therefore, since 6 is greater than 5, it implies that Mexico is relatively more labor abundant United States is relatively capital abundant, that is, 40/200 is greater than 10/60 b) Producing one unit of steel requires two machines and eight workers Therefore, one unit of steel is produced at a ratio of one machine to four workers, that is, 1:4 Producing one unit of bread requires one machine and eight workers One unit of bread is produced at a ratio of 1: 8 By comparing the two ratios, ¼ is greater than 1/8, that is, producing one unit of steel requires more machines in relation to workers as compared to production of a unit of bread. This therefore implies that steel is relatively capital-intensive. On the other hand, four workers and one machine are required to produce a unit of steel and eight workers and one machine are required to produce a unit of bread. Therefore, by comparing the two ratios, that is, workers in relation to machines, it is quite clear that more workers in relation to machine are needed in producing a unit of bread as compared to workers in relation to machine needed to produce a unit of steel. This therefore implies that bread is labor-intensive. c) Basing on Heckscher-Ohlin theory, Mexico will export bread and import steel while United States will export steel and import bread. Heckscher-Ohlin, in his theory, argues that trade normally arise when there is variations in relative prices of different commodities in different nations. Variation in commodity prices normally a rise as a result of variation in factor prices. Factor prices do always differ because endowments such labor and capital vary in various nations. Therefore, trade will always occur because various nations have various factor endowments. Heckscher Ohlin theory suggests that nations which have abundant labor will export goods that are labor intensive and nations which have abundant capital will export goods that are capital intensive. It is believed that, basing on assumptions stated by Heckscher-Ohlin, a nation will exports commodities which utilize relatively huge amount of its abundant and inexpensive factor and import commodities whose production needs intensive use of nation’s scarce and expensive factor. Mexico is relatively more labor abundant as compared to United States. United States on the other hand is more capital abundant as compared to Mexico. Steel is relatively capital intensive as compared to bread while bread is relatively labor intensive. Therefore, by considering Heckscher-Ohlin theory, Mexico will export goods that are labor intensive since it has abundant labor and import goods that are capital intensive while United States will export goods that are capital intensive since it has abundant capital and import goods that are labor intensive. This therefore implies that Mexico will export bread and import steel. United States of America will export steel and import bread. Question four a) i) Doubling capital in a large nation that has abundant capital will greatly increase its production. Changes in production can well be explained by considering Rybczynski theorem.Rybczynski theorem states that for a given relative prices of goods and services, an increase in factor endowment will enhance production in the sector that employs the factor intensively and decrease production in other sector(Ossa, 2010). Therefore, an increase in capital in a nation that has more capital as compared to labor will cause the country’s production possibility curve to shift slightly to the right. However, the shift will be in favor of the good that uses capital more intensively, that is, production of good that employs capital intensively will be enhanced. For instance, if a nation is capital abundant and commodity Yand Xare capital and labor intensive good respectively, then doubling capital will enhance possible outputs for both commodity Y and X. However, shift in Y will be greater than shiftin X. X will shift by a small margin as shown in the diagram below. PPF for Nation 2: capital abundant and labor scarce nation From the above production possibility frontier for Nation 2, it is clear that doubling capital alone enhance possible outputs for both commodity Y and X, that is, intercepts of PPF on axes extend outwards. The increase in Y is greater than the increase in X. For any given relative price, that is Px/Py, the optimal point for commodity Y raises. The optimal point for commodity X on the other hand slightly reduces as shown in the above graph. Production of Y is greater than production of X since doubling capital enhance capital to labor ratio. It is believed that with constant returns to scale, a higher capital to labor ratio results to higher relative production of capital intensive goodat any given relative prices. Doubling capital therefore enhances supply of commodityin the country that has relatively larger capital to labor ratio. The following diagram shows how doubling capital will enhance supply in a country that has relatively larger capital to labor ratio. RS is the relative supply curve for nation 2 while RS* is the relative supply curve for nation 1. Doubling capital in nation 2 will cause its supply curve to shift outwards to the right as shown in the above graph. Therefore, nation 2 will continue having comparative advantage is producing good Y when capital is doubled. ii) If capital is a scarce factor of production, doubling it will cause production possibility frontier to shift by small margin. Doubling capital will increase amount of available capital in a nation. This intern will enhance production of good that utilizes capital intensively. However, the relative increase will be much less. The increase in production will be less as compared to if capital was abundant factor of production. Doubling capital enhances its availability in the economy, thus reducing labor to capital ratio (Ossa, 2010). If X is labor intensive good and Y capital intensive good, then production of both commodity X and Y will increase due to Rybczynski effect. The increase in production of commodity Y and X will be represented by biased shift of production possibility frontier. The shift will be in favor of a good that employs labor intensively as shown below. b) i) In a small trading nation that has abundant capital, doubling capital will greatly enhance production of capital intensive good. It is believed that if both labor and capital are doubled, production possibility frontier of a nation will shift to the right in same proportions due to constant returns to scale. However, if only one factor increases relative to the other, the shift of production possibility frontier will be in favor of a good that employs the increased factor intensively. For instance, if Y is capital intensive good and X is labor intensive good. Then doubling capital will generally enhance the entire production in a two product economy, say Nation 2. However, the increase in commodity Y will be greater than the increase in commodity X. The effect of doubling capital in a two product economy is clearly shown in the diagram below. From the above diagram, it is clearly that for any given relative price, that is, Px/Py, doubling capital enhances production of commodity Y more than commodity X. The biasness in production is due to the fact that doubling capital enhances capital to labor ratio. It is believed that with constant returns to scale, higher capital to labor ratio normally results to higher production of capital intensive good. Doubling capital will enhance trade in a small trading nation. Higher capital to labor ratio implies higher production. The increase in production increases supply of commodity that employs capital intensively. Increased supply reduces prices, thus causing more commodities to be demanded by another trading nation. ii) If capital is a scarce factor of production, doubling it will reduce labor to capital ratio. The production possibility frontier will shift but with small margin. The shift however will be in favor of the good that utilizes labor intensively. In this case, the increase in commodity X will be greater than the increase in commodity Y since X is labor intensive good. Production of commodity Y will reduce relative to production of commodity X if capital is doubled. The following diagram shows the effect of doubling capital in a small nation if capital is a scarce factor of production. From the above diagram, it is clear that when a scarce factor of production is doubled, in a two sector economy, production of commodity that employs abundant factor will be greatly affected, thus affecting trade in that economy. Doubling capital in nation 1 for instance will reduce its exports. Exports reduce since doubling capital has an effect of reducing relative supply in a two sector economy. Nation 1 has a comparative advantage of producing commodity X. When available capital is increased, say doubled, production of commodity X will slightly reduce thus reducing commodity X relative supply. Question five Australia has for along time been an active and open trading nation. Its involvement in international trade has made it a prosperous nation. Australia economy highly depends on international trade. Of late, Australia does not only trade with European nations but also with other nations from Asia and America. It is believed that Australia trades with more than two hundred nations, with European nations accounting for approximately two-thirds of entire trading partners. Its exports do always generate at least 20 per cent of gross domestic product. In the year 2010, alone, Australia recorded trade surplus of $16.8 billion. Currently, Australia has recorded $5.8 billion trade surplus in 2011-2012 financial year. This is an indication of high dependence in international trade (AGDFAT, 2012). Australia’s level of dependence on international trade has changed over years. In the past years, Australia level of dependence on international trade was lower as compared to current years. The dependence level, in the years 1975 to 2009, was lower since Australia was experiencing balance of payment deficit. Deficit in balance of payment is an indication that less goods and services are exported as compared to those being imported. It also indicates that a country concentrates more in domestic market than international market. Therefore, in the years 1975 to 2009, Australia majorly relied on domestic market than international market. In the year 2000, Australia exported commodities worth $65.6 billion, which was higher than $62.9 recorded in 1999. The growth in export value was an indication of continuous growth in international trade. The trade balance deficit in 2000 reduced from 8.4 percent to 5.6 percent of export volume. In 2010, Australia foreign trade grew strongly recording $16.8 billion trade surplus. Australia has also experienced trade surplus in the year 2011. This therefore indicates that Australia is currently concentrating more in international market than domestic market(AGDFAT, 2011). Australia mainly exports agricultural products, minerals and energy. Wheat and wool are among the agricultural products that Australia exports while iron-ore and gold are among the minerals that the nation exports. Australia normally exports its energy in form of coal and liquefied natural gas. According to Trading Economics (2012), the entire Australian exports are dominated by mineral products, agricultural products and energy. Mineral products accounts for approximately 57% of entire exports while agricultural products accounts for approximately 15.3%. Historically, Australia exports have been increasing. From 1971 to date, Australia exports have increased to an average of 8145.1 million Australia dollars. In August 2011, Australia exports recorded an all time high of 28040 million Australian dollars. Australia exports its products to many countries around the world. This therefore implies that Australian exports occupies large share in international market. Transport equipment, machinery, office machines, computers and telecommunication lacers are the main products that Australia imports. It is quite clear that Australia’s main imports are manufactured products. Australia imports majority of the manufactured products from China, Japan, European Union, Singapore and United States. Its largest export markets include China, United States, Japan, European Union and South Korea. Therefore, the share of Australian imports in international market is big. Having large share in international market made Australia import goods worth 27051 million Australian dollars in May 2012. This was a very high value ever recorded since May 1972 when Australia recorded a low of 396 million Australian dollars. Australia’s main trading partners are China and European Union. European Union is the second trading partner after China. Trade between Australia and European Union has been growing steadily until 2009 when global economic crisis occurred. The global economic crisis made Australia to start trading more with Asian countries such as China, thus making European Union a second trading partner. Australia mainly trades with European Union because they are parties to a bilateral accord that aims at facilitating trade of manufactured products among the two nations. The accord aims at attaining its objectives through minimization of technical barriers such as assessments and procedures. Therefore, Australia trades more with European Union so as to easily facilitate its importation of manufactured goods. Majority of Australia products are currently exported to China. Since 2009, China has become largest export market for Australia commodities. It is because of this large export market for Australia products that makes Australia trade more with China. Therefore, the huge export market makes China number one trading partner. For the past few years there has been a tremendous increase in the volume of goods and services exported to China. In 2009, Australia exported merchandise worth 42.4 billion Australia dollars to China, which was 31.2% increase over the past period. In the same year, Australia exported services, worth 5.5 billion Australian dollars, to China. The services entailed educational and recreational travel (Reilly, 2012). The trading patterns between Australia and China are consistent with Hechscher-Ohlin theory. In his theory, Ohlin suggested that a country will export goods and services that are produced with resources which are relatively abundant at home and imports commodities that are produced with relatively scarce resources at home. According to ABARE (2005), Australia enjoys abundance of agricultural land, energy and mineral resources per individual relative to other nations. This therefore gives it comparative advantage over these products. China on the other hand has abundant labor. It has greater comparative advantage for exporting labor intensive light manufactures such as machines, foot wears, electronics, office equipment and telecommunication lacers. It is therefore clear that bilateral trade pattern between China and Australia is consistent with relative resource endowments of each nation. Australia and China trade pattern is consistent with the trade patterns predicted by Hechscher-Ohlin(ABARE,2005). The trading patterns between Australia and European Union contrast to Hechscher-Ohlin theory. Australia imports many products from European Union. European Union on the other hand does not import products from Australia. Therefore, the trade between Australia and European Union is one way. Australia only imports from European Union. Its exports to European Union are very minimal. Majority of exported goods in European Union are produced by both abundant and scarce resources, which is not consistent with Hechscher-Ohlin theory. Hechscher-Ohlin theory expects a country to only exports goods which it enjoys abundant resources. Bibliography Akrani,G. (2011). Ricardo's Theory of Comparative Advantage - International Trade.Retrieved on August 22nd, 2012 from Marrewijk,C. (2007).Absolute Advantage. World Economy. Retrieved on August 24th, 2012 from Nirav S. (2012). Adam Smith's Theory of International Trade - The Law of Absolute Cost Advantage of International Trade.Retrievedon August 25th, 2012 from Carbaugh,R. (2010).International Economics. London: Cengage Learning. ABARE. (2005). Department of Economics, Erasmus University Rotterdam. Retrieved on August 26th, 2012 Australian Government Department of Foreign Affairs and Trade (AGDFAT). (2011). Trade at a Glance 2011. Retrieved on August 25th, 2012 from Reilly,J. (2012). Jingdong YuanAustralia and China at 40. UNSW Press. Ossa, R. (2010). Trade and Resources: The Heckscher-Ohlin Model. Trading Economics. (2012). Australia exports. Retrieved on August 26th, 2012 from Read More