ECO203 International Economics – Comparative Advantage & Trade Theory

Question 1

There are two countries, Brazil and India. They use all their resources (i.e., labour and capital) to produce printed circuit boards (PCBs) and food products (FPs).

Brazil can produce either 9,000 units of PCBs or 6,000 units of FPs. India can produce either 6,000 units of PCBs or 15,000 units of FPs.

a) State which country has absolute advantage and comparative advantage in the production of PCBs and FPs and solve the mutually beneficial terms of trade?

b) Using the Heckscher-Ohlin theory of trade, illustrate in detail the patterns of trade between Brazil and India and demonstrate it with appropriate diagrams (PCBs on the y-axis and FPs on the x-axis). There is presence of diminishing marginal productivity.

You are also expected to discuss the Production Possibility Frontier (PPF), opportunity costs, specialisations, gains from trade, welfares and any other relevant inferences and implications of the Heckscher-Ohlin theory.

(Note: The use of numerical examples is not required, however, labelling correctly relevant points before and after trade is necessary.)

c) Explain the trade theory of economies of scale and product differentiation and demonstrate how both of these theories matter in international trade with real world examples.

Expert Answers on Above International Economics Assignment

Absolute and comparative advantage

An analysis of absolute advantage from the data provided indicates that Brazil produces 9000 PCBs whereas India produces 6000 PCBs, and this indicates Brazil has absolute advantage. With respect to FPs, Brazil produces 6000 while India produces 15000, and it shows India has absolute advantage.
Opportunity cost analysis: The opportunity cost for Brazil is 1 PCB=6000/9000 which is .67 FP and 1 FP = 9000/6000 and it is 1.5 PCBs. For India, 1 PCB=15000/6000 which is 2.5 FPs and 1FP=6000/15000 which is .4 PCBs.
Comparative Advantage: For PCBs, Brazil has comparative advantage because it has lower opportunity cost compared to India whereas in respect to FPs, India has comparative advantage because of lower opportunity cost compared to Brazil. This implies that Brazil should specialise in PCBs and India in FPs.
Mutually beneficial terms of trade: The mutually beneficial terms of trade is any price between PCB and FP cost across both countries.

Heckscher Ohlin (H-O) Theory and trade pattern

Basic idea of theory: The basic idea behind this theory is countries that make use of their abundant factors intensively usually export goods. For example, if Brazil is capital abundant and India is labour abundant, and PCBs is capital incentive while food products is labour intensive, and trade pattern is assumed as brazil export PCBs, and India export FPs, the production possibility Frontier would be downward sloping because of scarcity of resources and bowed outward because of diminishing marginal productivity. The increasing production of one good by a country leads to sacrificing an increasing amount of the other. Before the trade, the production and consumption by each country was carried out within its own PPF but after specialisation Brazil move towards the PCB axis and India move towards the FP axis.
Gains from the trade: The gains will be in terms of higher Global output, better utilisation and allocation of resources and increased welfare in both countries.

Other implication of this theory

The other major implication includes changes in the income distribution because of higher trade and it also encourages specialisation.

Economies of scale and product differentiation

Economies of scale occur when the output increases which results in decline in the average cost whereas product differentiation is offering something unique in the product and satisfies consumer demand for variety.

This model answer is reviewed by Dr Enze Huang, familiar with international economics concepts and theories.
Disclaimer: This answer is a model for study and reference purposes only. Please do not submit it as your own work.

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