Exam (elaborations)
ECS3702 - International Trade (ECS3702) Exam Pack from Nov2018 to June2021
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Exam (elaborations) ECS3702 - International Trade June2021 Exam Memo
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ECS3702 EXAM PACRalph: +27 68 077 9615
Email:
http://theeconomistsoe.com/
, THE ECONOMIST SCHOOL OF ECONOMICS
ECS3702: INTERNATIONAL TRADE
MAY/JUN 2021
EXAM MEMO
QUESTION 1 [25 marks]
(i) Identify the commodity in which Lesotho and Botswana have an absolute advantage and
absolute disadvantage [4 marks]
The principle of absolute advantage refers to the ability of a party to produce a good or service more
efficiently than its competitors. Adam Smith first described the principle of absolute advantage in the
context of international trade, using labor as the only input.
Lesotho has absolute advantage in the production of both wool and beef.
Botswana has a absolute disadvantage in the production of both wool and beef.
(ii) Indicate the commodity of each nation’s comparative advantage and disadvantage. Show your
workings. [6 marks]
Output Lesotho Botswana
Wool [ ton/hr] 4 [ 4/3=1,33] 1 [1/2=0.5]
Beef[ ton /hr] 3 [3/3=1] 2 [2/2=1]
Lesotho has a comparative advantage in the production of wool as it sacrifices 1 beef to produce 1,33
wool where as Botswana has a comparative disadvantage in the production of wool as it sacrifices 1
beef to produce only 0,5 wool. However Botswana has a comparative advantage in the production of
beef as it only sacrifices 0,5 wool to produce 1 beef whilst Lesotho sacrices 1,33 wool to produce the
same that is 1 beef.
(iii) If Lesotho exchanges 4W for 4B with Botswana,
(a) How much does Lesotho gain in terms of beef? [2 marks]
It will gain an additional 1 ton of beef.
(b) How much does Botswana gain in terms of beef? [2 marks]
Botswana will gain an additional 2 ton of beef.
(c) What is the range of mutually beneficial trade? [3 marks]
The range of mutual beneficial trade is: 1<2<4
QUESTION 1B
Briefly explain the theories of absolute and comparative advantage, highlighting any similarities
and differences between the two. [8 marks]
According to Adam Smith, trade between two nations is based on absolute advantage. When one
nation is more efficient than (or has an absolute advantage over) another in the production of one
commodity but is less efficient than (or has an absolute disadvantage with respect to) the other
nation in producing a second commodity, then both nations can gain by each specializing in the
production of the commodity of its absolute advantage and exchanging part of its output with the
other nation for the commodity of its absolute disadvantage.
According to the law of comparative advantage, even if one nation is less efficient than (has an
absolute disadvantage with respect to) the other nation in the production of both commodities, there
is still a basis for mutually beneficial trade. The first nation should specialize in the production and
export of the commodity in which its absolute disadvantage is smaller (this is the commodity of its
, THE ECONOMIST SCHOOL OF ECONOMICS
comparative advantage) and import the commodity in which its absolute disadvantage is greater (this
is the commodity of its comparative disadvantage).
Differences: The theory of absolute advantage goes a step further to emphasize that if one nation has
an absolute advantage in the production of both goods trade is not mutually beneficial however with
regard to the theory of comparative advantage trade is still beneficial even if one nation has absolute
advantage in the production of both goods.
Similarities: Both theories believe any economy has limited resources and there will be opportunity
cost for making any product.
QUESTION 2 [25 marks]
QUESTION 2A
FIG 1
You are given the following hypothetical scenario: Two countries, lunchi and Punchi. Lunchi is a
capital abundant country and Punchi is a labour abundant country. Both countries consume and
produce iron and leather. Iron is capital intensive and leather is labour intensive. Using a graphical
representation of Punchi, explain the two components of the gains from trade.
QUESTION 2B
Assume two countries, Malawi and Japan, Malawi is labour abundant, and Japan is capital
abundant. Assume further that Good A is labour intensive and good B is capital intensive.
Explain how trade between the two countries will affect factor prices and how income will
be distributed in the two countries. [10 marks]
The Factor price Equalization Theorem or the H-O-S Model
This theorem says that international trade will cause the wage rate of homogenous labour and the
rental price of capital (interest rate) to be the same in all trading nations (Malawi and Japan). Both
relative and absolute factor prices will be equalised. International trade will bring about equalization
, THE ECONOMIST SCHOOL OF ECONOMICS
in the relative and absolute returns to homogeneous factors across nations. As such, international
trade is a substitute for the international mobility of factors.
The H-O-S is derived from the H-O and holds if the H-O holds thus, it shares the same assumptions as
the H-O. This implies of this is that international trade will cause the wages of homogeneous labor,
(i.e, labor with the same level of training, skills, and productivity) to be the same in all trading nations.
Further, international trade will cause the return to homogeneous capital, that is, capital of the same
productivity and risk, to be the same in the both Malawi and Japan. As a result, international trade
will make (wage) to be the same in both nations and by the same reasoning, it will cause r (rental
cost) to be the same in the 2 nations. This will result in both relative and absolute factor prices being
equalized.
Before trade, the relative price of good A is lower in Malawi than in Japan because the relative price
of labor, or the wage rate, is lower in Malawi. As Malawi specializes in the production of good A (the
L-intensive commodity) and reduces its production of commodity Y (the K-intensive commodity), the
relative demand for labor rises, causing wages (w) to rise, while the relative demand for capital falls,
causing the interest rate (r) to fall. The exact opposite occurs in Japan. That is, as Japan specializes in
the production of B and reduces its production of A with trade, its demand for L falls, causing w to fall,
while its demand for K rises, causing r to rise.
In summary, international trade causes the wage to rise in Malawi which is the low-wage nation and
to fall in Japan (the high-wage nation). Therefore, international trade reduces the pre-trade difference
in wages between the two nations. Similarly, international trade causes r to fall in Malawi (the K-
expensive nation) and to rise in Japan (the K-cheap nation), thus reducing the pre-trade difference in r
between the two nations. This proves that international trade tends to reduce the pre-trade
difference in wages and rental cost between the two nations thus equalizing the income in both
countries.
QUESTION 3A
(i) If the nominal tariff rate on consumers of leather shoes is 40 percent, the ratio of
imported leather to leather shoes in the absence of tariff is 0.5 and the nominal tariff rate
on leather is 40 percent, calculate the effective rate of protection afforded to producers.
g=(t-aiti)/1-ai
where g = the rate of effective protection to producers of the final commodity
t = the nominal tariff rate on consumers of the final commodity
ai = the ratio of the cost of the imported input to the price of the final commodity in the
absence of tariffs
ti = the nominal tariff rate on the imported input
Therefore:
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