The above table shows that Mike incurs high opportunity cost while making T-shirts. The reason behind this – Johnson can produce T-shirts at a low opportunity cost and Mike can produce hamburger at a low opportunity cost. Hence, Johnson will produce more of T-shirts and Mike should produce more of hamburgers.
Comparative advantage theory shows the advantage that an individual can have by producing a commodity more efficiently for getting economic benefit rather than producing another commodity. Thus comparative advantage provides a framework that country’s should follow, the frameworks shows that a country should produce that commodity in which efficient production is achieved (at lower opportunity cost) than other commodities (Laursen, 2015).
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Opportunity cost of 1 hamburger
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Opportunity cost of 1 T-shirt
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Mike
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0.3
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3.3
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Johnson
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0.5
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1.75
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Table 2: Opportunity cost
The above table shows that Mike has comparative advantage in producing hamburgers. The reason behind this is, producing hamburger incurs low opportunity cost to Mike than producing T-shirts which incurs high opportunity cost. Hence in order to benefit from trading, Mike will produce hamburgers in order to reap benefits from trade.
Question 3
a) Production possibility frontier shows the maximum output possibilities of two goods, given the inputs and factors of production. Labor, capital and technology all are factors of production. Thus PPF provides different production bundle represented in form of points on the curve and point lying on PPF are efficient ones while points inside PPF are considered inefficient points and points outside PPF is impossible to attain (Benhabib and Nishimura, 2012).Let us now consider two countries home and foreign, both produces two goods good 1 which uses labor and capital and good 2 which use labor and land. The production functions of two goods are:
Production Function of good 1 Q1=Q1 (K1, L1)
Here Q1 refers to economy’s output of good 1, K1 is economy’s capital stock and L1 is the labor force employed in good 1.
Production Function of good 2 Q2=Q2 (K2, L2)
Here Q2 refers to economy’s output of good 2, K2 is economy’s capital stock and L2 is the labor force employed in good 2.
The condition for full employment requires the supply of labor employed in good 1 plus supply of labor employed in good 2
L1+ L2=L
Initially both countries have same supply of labor, capital and land. Now if capital stock of home country increases then it impacts PPF. Due to lack of land, home will produce a high ratio of good 1 to good 2 at any given prices.
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Diagram 1: Changing capital stock
Diagram 1 shows relative supply curve is P2XMPL2 and relative demand curves are P1XMP1L1 and P1XMP1L12 , W1 and W 2 are wage rates . Now increase in capital supply shifts supply curve to outward and increase in supply of labor shifts supply curve to inward. Thus home has more capital per worker than foreign on the other hand foreign has more land per worker. Thus in autarky situation relative price of good 1 in home country is lower than the relative price in foreign in autarky situation. Thus trade leads to convergence of relative price.
b) Both countries have same supply of labor in autarky situation. Now with trade capital stock of home country increases then it impacts PPF. Due to lack of land, home will produce more good 1 and foreign will produce more good 2.
Diagram 1: Changing capital stock
Diagram 1 shows relative supply curve is P2XMPL2 and relative demand curves are P1XMP1L1 and P1XMP1L12 , W1 and W 2 are wage rates . Now increase in capital supply shifts supply curve to outward and increase in supply of labor shifts supply curve to inward. Thus home has more capital per worker than foreign on the other hand foreign has more land per worker. Thus in autarky situation relative price of good 1 in home country is lower than the relative price in foreign in autarky situation. Thus trade leads to convergence of relative price.
Opening up to trade between home and foreign country provides benefit to both the countries. The pattern of trade is thus given below.
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Diagram 2: Pattern of trade
The above diagram shows that country that cannot participate in trade then the output of that country equals its consumption. Now if the country involves itself in trade then, international trade makes it possible to consume the goods which the country doesn’t even produce, thus the mix of two goods can be consumed. Opening up to trade shifts relative prices of good 1 and good 2. Thus pattern of trade shows that home will export good 1 and foreign will export good 2. This pattern is followed because capital stock increases in home and good 1 uses capital and labor and good 2 uses labor and land.
Considering diagram 2, opening up to trade shows that trade benefits the factors that are specific to export, here capital and land will be affected as these factors used in the export commodities. Home country exports good 1 which involves use of capital and labor and foreign country exports good 2 which involves use of land and labor. Thus trade affects factors that are specific to export, but affects the import sector. Effect of trade on labor is ambiguous.
Question 4
- A country does not engage in trade can benefit from trade only if-Pre-trade and
Free-trade relative prices are not identical.
- The effect of trade on specialized employees of exporting industries will be more jobs and higher pay because they are relatively immobile.
- The Ricardian model of international trade demonstrates that trade can be mutually beneficial. Why, then, do governments restrict imports of some goods?
Answer-Trade can have substantial effects on a country’s distribution of income
- In the specific factor model, a country’s production function is a curved line because of diminishing marginal returns.
- The effect of trade on income distribution can be significant in the short run
References
Benhabib, J. and Nishimura, K., 2012. Competitive equilibrium cycles. In Nonlinear Dynamics in Equilibrium Models (pp. 75-96). Springer Berlin Heidelberg.
Jablonski, B.B.R., Schmit, T.M. and Kay, D., 2016. Assessing the economic impacts of food hubs on regional economies: A framework that includes opportunity cost. Agricultural and Resource Economics Review, 45(1), pp.143-172.
Kurzban, R., Duckworth, A., Kable, J.W. and Myers, J., 2013. An opportunity cost model of subjective effort and task performance. Behavioral and Brain Sciences, 36(6), pp.661-679.
Laursen, K., 2015. Revealed comparative advantage and the alternatives as measures of international specialization. Eurasian Business Review, 5(1), pp.99-115.
Ruijs, A., Wossink, A., Kortelainen, M., Alkemade, R. and Schulp, C.J.E., 2013. Trade-off analysis of ecosystem services in Eastern Europe. Ecosystem services, 4, pp.82-94.
Schumacher, R., 2012. Adam Smith's theory of absolute advantage and the use of doxography in the history of economics. Erasmus Journal for Philosophy and Economics, 5(2), pp.54-80.
