COURSE: BCOM FINANCE PART TIME

FIN 2305: INTERNATIONAL FINANCE. ASSIGNMENT ONE.

INSTRUCTIONS:
1. Answer all questions.
2. Show relevant workings.
3. Hand in your answers document through the virtual campus platform within
seven (7) days as from 4th July 2023.

Question
a) As a scholar in International Finance, you are aware that International Trade is
underpinned by various theories. In this context, explain the Ricardian Theory’s
comparative advantage concept. [2 marks].

ANSWER.

The Richardian model was proposed by David Richardo.It suggests that countries should
specialize in producing goods and services in which they have a lower opportunity cost
compared to other countries. According to this theory, the opportunity cost of producing a
good or service is measured in terms of the alternative goods or services that must be
sacrificed to produce it.

Assume that countries A and B produce all their own food and machinery. Country A is more
efficient at food production and country B is more efficient at Machinery production. Then
international trade is introduced. Country A reduces its machinery production by 5% to 95%
and with those resources increases its food production by 18% to 118% of before
international trade levels. Country B reduces its food production by 6% to 94% and with
those resources increases its machinery production by 12% to 112% of before international
trade levels.
Required:
By applying the absolute advantage theory of international trade, demonstrate how
country A and B will trade to achieve gains from international trade. [3 marks].

Answers.

Description. Country A Country B

Machinery Food Machinery
Food
Before
international 100% 100% 100% 100%
trade A and B
are self-
sufficient.
Specialization
due to 95% 118% 112% 94%
international
trade.
Exchange: B
trades surplus +6% _8% _6% +8%
machinery for
As surplus food
Total after
exchange 101% 110% 106% 102%

Country A exchanges 8% of its food surplus in exchange for 6% of Bs machinery surplus.

Both countries are now better off as they now have more food and more machinery than
before international trade.