QUESTION 1
- Gain from trade.
No, gain from the trade. The main sources of gains from trade are usually division of labor, extended market size, lower per-unit cost, specialization and bulky manufacture made probable by the trade and invention and introduction of recent manufacturing methods. In this case, foreign country has an absolute advantage in the production both of toasters and ovens, but it has the same comparative advantage in both toasters and ovens because it is equally better at producing the two products. Foreign Country is 1.25 times better at toasters and 1.25 times better at ovens. The opportunity cost of producing toaster in home country and foreign country is 2 and the opportunity cost of producing oven in both home and foreign countries is 0.5. From the analysis, it is evident that both countries will have no competitive advantage in specialization because they stand to gain nothing from the trade, when they do specialization (Irwin, 2020).
Table 1:Consumption of Labor.
| TOASTERS | OVENS | |
| HOME | 20 | 40 |
| FOREIGN | 25 | 50 |
Table 2: Opportunity Cost.
| TOASTERS | OVENS | |
| HOME | 2 | 0.5 |
| FOREIGN | 2 | 0.5 |
- 10 % in Oven for Home Country.
110% of 40 = 110/100 x 40 = 44
Both countries agree to trade only 3400 toasters.
Therefore,
The number of toasters that Home country can trade will be;
The number of toaster that a Foreign country can trade will be:
Table 3: Consumption of labor.
| TOASTERS | OVENS | |
| HOME | 6.8 | 44 |
| FOREIGN | 8.5 | 50 |
Table 4:Opportunity Cost.
| TOASTERS | OVENS | |
| HOME | 6.5 | 0.15 |
| FOREIGN | 5.9 | 0.17 |
Table 5: Specialization.
| TOASTERS | OVENS | |
| HOME(500) | 3250 | 75 |
| FOREIGN(400) | 2360 | 68 |
In autarky, comparative costs are equivalent to the opportunity cost of producing a product. This is because, when a positive amount of both products are required, in equilibrium, the price of buying a product should be equivalent the price of producing the product. when positive amounts of equal products are required by each nation, then the after trade cost should either be equivalent to it, or lie in between the two autarkic comparative costs. A nation will do business whichever product for which they have a relative benefit. From the calculations above, being that home country has a lower opportunity cost of toaster in terms of oven, they will export toaster and the foreign country will export oven. The production and consumption bundles for home countries are 3250 for toasters and 75 for Ovens.
- 4 % in Oven for Home Country.
104% of 50 = 104/100 x 50 = 52
Table 6: Consumption of labor.
| TOASTERS | OVENS | |
| HOME | 6.8 | 44 |
| FOREIGN | 8.5 | 52 |
Table 7: Opportunity Cost.
| TOASTERS | OVENS | |
| HOME | 6.5 | 0.15 |
| FOREIGN | 6.1 | 0.16 |
Table 8: Specialization.
| TOASTERS | OVENS | |
| HOME(500) | 3250 | 75 |
| FOREIGN(400) | 2440 | 64 |
A nation will do business whichever product for which they have a relative benefit. From the calculations above, being that home country has a lower opportunity cost of toaster in terms of oven, they will export toaster and the foreign country will export oven. The production and consumption bundles for home countries are 3250 for toasters and 75 for Ovens.
- Production Possibility Frontiers for Home and Foreign
- Production Possibility Frontiers for Home and Foreign for question b above.
Figure 1:Production Possibility Frontiers for Home and Foreign.
- Production Possibility Frontiers for Home and Foreign for question c above
Figure 2:Production possibility frontiers for home and foreign countries.
QUESTION 2
Countries can gain from trade even if they both face increasing opportunity costs. In the diagram below, two countries, Foreign country (Country A) and the Home country (Country B), specializes in producing two goods, Good X and Good Y. Based on resource endowment, both countries are producing products that have a comparative advantage over, for instance, Country A Produces Clothes (Good Y). In contrast, Country B Produces Cotton (Good X). Under autarky, the foreign country produces eight units of clothes and two units of cotton fiber, while the Home country produces ten units of cotton fiber and two units of clothes. Based on the rule of supply and demand, it is evident that the relative price of cotton will be high in a foreign country as compared to the home country. In autarky, gain from trade is based on the ratio between the production bundles and the consumption bundles; therefore, based on the economic point of view of a rational consumer, to maximize welfare, the home country needs to produce at the highest indifference curve tangent to the PPF to enjoy economies of scale. This applies to both cotton and cloth production.
Under specialization, in a two-country world, both countries will have skewed PPF biased towards the good they have a comparative advantage in, thus leading to free trade. The relative prices in a free trade economy are achieved when the quantity of what home country exports are equal to the quantity of what foreign country imports such that it will fall in between the autarky relative prices for the two countries. This trade pattern under this setup ensures that both countries gain from the trade because the technological specialization and resource endowment will permit them only to produce that product each has a comparative advantage. As a result, the foreign country will produce and export Clothes when the Home country will produce and trade in Cotton fiber. Therefore, the foreign country will convert the labor they investing in producing two units of cotton to maximize on cloth production. In comparison, the home country will convert the labor they are using to produce the two units of clothes to maximize cotton fiber production. This resource transfer will ensure that each country enjoys economies of scale.
Figure 3: Production Possibility Curve for both Autarky and free trade.
QUESTION 3
- Small open economy.
- It is an Import quota; it is a category of trade constraint that fixes a physical limit on the quantity of a product that can be imported into a nation in a specific duration of time. Quotas, like other trade limitations are usually used to advantage the producers of a product in an economy.
- Importing consumers of a good in the importing nation are worse-off due to the tariff. The rise in local prices of equally imported products and the local substitutes lessens customer excess in a market.
Importing producer’s in the importing nation are better-off due to the tariff. The rise in prices of the good raises producer excesses in the trade. The price rises also encourage a rise in employment, a rise in output of current industries and a rise in profit.
The importing government obtains tariff revenue due to the tariff. This resources assist in supporting different government expenditure plans, hence, everyone in a nation are prospective beneficiary of these gains.
- Graphs.
Figure 4: Demand and supply curve of small open economy.
- Large open economy.
- It is an Import quota; it is a category of trade constraint that fixes a physical limit on the quantity of a product that can be imported into a nation in a specific duration of time. Quotas, like other trade limitations are usually used to advantage the producers of a product in an economy.
- Importing consumers of a good in the importing nation are worse-off due to the tariff. The rise in local prices of equally imported products and the local substitutes lessens customer excess in a market.
Importing producer’s in the importing nation are better-off due to the tariff. The rise in prices of the good raises producer excesses in the trade. The price rises also encourage a rise in employment, a rise in output of current industries and a rise in profit.
- Demand and supply of large open economy.
Figure 5:Demand and supply curve of open economy.
QUESTION 4
- Export restrictions due to COVID-19 has led to supply disruption and price fluctuations for various products globally. Production of PPE requires raw materials, and now that public and air transport has been banned internationally due to the global pandemic, we can assume that the supply of raw materials has also reduced. To respond to this, PPE producing countries imposed export bans on the product for self-sufficiency purposes because the duration of COVID-19 is not specific. The exporting countries had a competitive advantage in producing the PPE than the importing countries. This has led to a loss to the exporting countries as those useful labor units for manufacturing PPE for export were converted to none effective use. On the other hand, the importing countries decided to produce their PPE. As a result, they have gained in terms of employment as their citizens have been employed in the PPE manufacturing companies.
In general, employees in PPE exporting countries have recorded a loss in terms of income as they are laid off from their lucrative employment, while in the PPE importing countries where PPE is on high demand, employees in those PPE producing companies are recording a gain in income due to high demands of PPE. In the short run, the export ban is expected to have an impact on PPE prices and supply worldwide. The relative prices have gone down in the PPE exporting countries due to excess supply and less demand, while in the PPE importing countries, the relative prices have gone high due the less supply and more demand as a result of the ban.
Figure 6: Exporting Countries.
Figure 7: Importing Countries.
- Terms of Trade (ToT) refers to the exchange rate between two different products in a scenario of inter-trade between two countries. It is the ratio between the export prices and the import prices. According to the theory of comparative advantage by David Ricardo, if one nation is specialized in producing one commodity, say, for example, grains in Canada, then all other countries, say, importing countries where the grains were being exported to can go beyond its PPF and gain from trade. Terms of trade are the best terminology that explains how the gain from trade is distributed.
About 94% of the total of Canada’s annual grain exported is moved by rail. The rail blockades disrupted the grain flow for shipment, something which led to less grain being exported. The reduction in quantity shipped resulted in a decline in the exchange rate, which signifies a reduction in terms of trade. This implies that Canada has very little grain export to buy them more imports of products they have a less comparative advantage in producing; therefore, it means that their terms of trade have deteriorated because the price of the exportable commodities say grains will go down while the prices of importable products will go high.
As a result of the rail blockades, there was an excess supply of wheat in the domestic market, accompanied by less demand for the product. This impacted negatively on the domestic prices of wheat in Canada because the supply exceeded the demand.
References
Burke, M., Bergquist, L. F., & Miguel, E. (2019). Sell low and buy high: arbitrage and local price effects in Kenyan markets. The Quarterly Journal of Economics, 134(2), 785-842.
Irwin, D. A. (2020). Free trade under fire. Princeton University Press.
