1.

Explain the principle of comparative advantage and differences between it

and the principle of absolute advantage.
a. Comparative advantage is an economy's ability to produce a particular good or service
at a lower opportunity cost than its trading partners. Comparative advantage is used to
explain why companies, countries, or individuals can benefit from trade.

When used to describe international trade, comparative advantage refers to the products
that a country can produce more cheaply or easily than other countries. While this usually
illustrates the benefits of trade, some contemporary economists now acknowledge that
focusing only on comparative advantages can result in exploitation and depletion of the
country's resources.

b. Absolute advantage is the ability of a country to produce a higher quantity of a good or

service with respect to other countries using the same amount of resources. The
concept of absolute advantage was first described by the economist "Adam Smith". In
simple words, if a country can produce the same quantity as other countries more
efficiently using fewer amounts of resources, then it said to have an absolute
advantage. Absolute advantage deals with productivity.

Both absolute and comparative advantage, help the countries which possess either of those
advantages to increase their total welfare. The trading countries have to trade at the rate of
exchange, which falls within the ratio of their opportunity costs.

Both the concepts can be broadly applied to an individual, firm, or a country.

c. The primary difference between absolute and comparative advantage is:-

Absolute Advantages Comparative advantage

Absolute advantage is a concept that was Comparative advantage is a capitalist idea.

utilized in communist countries.

Absolute advantage refers to the ability to Comparative advantage refers to the ability
produce more of a good or service using the to produce a good or service at a lower
same amount of resources. opportunity cost.

Absolute advantage refers to the ability to Comparative advantage refers to the ability
produce a good or service at a lower to produce more of a good or service using
opportunity cost. the same amount of resources.

Absolute advantage can never change. Comparative advantage depends on the

Assignment of International Economics-I Page 1

 relative cost of agood’s resources.

2. Assume two countries the US and UK, two goods corn and textiles. Further
assume that labor is the only relevant input in production and in the pre-
trade situation in each country in the production of one unit of each product.
Accordingly, UK requires 9 and 18 units of labour; while the US requires 6
and 3 units labour to produce one unit of textiles and Corn respectively. Then
a. Which country has an absolute advantage in which product?
b. Indicate which country has a comparative advantage in production of a
certain good.
c. What is the maximum output each country can produce of the good it has a
comparative advantage in? What is the gain from this specialization?
d. Describe the pattern of trade that is possible if both countries enter into a
trade relationship.
e. Assume now, that the labor input requirements are 12 for textiles and 6 for
corn in the UK. Is it possible to define a comparative advantage or say
something about the trade pattern?
3. Home has 1,200 unit of labor available. It can produce two goods, apples and
bananas. The unit labor requirement in apple production is 3, while in banana
production it is 2.
a. Graph Home’s production possibility Frontier.
 Graph Home’s production possibility frontier. The production possibility
curve is a straight line that intercepts the apple axis at 400(1,200/3) and the
banana axis at 600 (1,200/2).

b. What is the opportunity cost of apples in terms of bananas?

The opportunity cost of apples in terms of bananas is 3/2. It takes 3 units of

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 labor to harvest an apple but only 2 units of labor to harvest a banana. If one
forgoes harvesting an apple, this frees up 3 units of labor. These 3 units of
labor could then be used to harvest 1.5 bananas.

c. In the absence of trade, what would the price of apples in terms of

bananas be? Why?
Labor mobility ensures a common wage in each sector, and competition
ensures the price of goods equals their cost of production. Thus, the relative
price equals the relative costs, which equals the wage times the unit labor
requirement for apples divided by the wage times the unit labor requirement
for bananas. Because wages are equal across sectors, the price ratio equals the
ratio of the unit labor requirement, which is 3 apples per 2 bananas.

4. State the H-O theorem. What is the Leontief paradox in reference to the H-O
theorem?

The Heckscher-Ohlin (H-O) theorem states that a country that is capital abundant will
export the capital-intensive good. Likewise, the country that is labor abundant will export
the labor-intensive good. Each country exports that good that it produces relatively better
than the other country. In this model, a country’s advantage in production arises solely
from its relative factor abundance.

What is the Leontief paradox in reference to the H-O theorem? The Heckscher-Ohlin
theorem gave a generalization that the capital-abundant counties tend to export capital-
intensive goods while labour- abundant countries tend to export the labour- intensive
goods. W.W. Leontief put this generalization to empirical test in 1953 and found the results
that were contrary – to the generalization provided by the H-O theory. Leontief made use
of 1947 input-output tables related to the U.S. economy. 200 groups of industries were
consolidated into 50 sectors, of which 38 traded their products directly on the international
market. He took only two factors of production— labour and capital.

5. What is the Stolpher-Samuelson theorem? Provide an intuitive explanation of

the theorem.

The Stolper-Samuelson theorem demonstrates how changes in output prices affect the
prices of the factors when positive production and zero economic profit are maintained in

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each industry. It is useful in analyzing the effects on factor income either when countries
move from autarky to free trade or when tariffs or other government regulations are
imposed within the context of a Heckscher-Ohlin (H-O) model

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