In: Economics
QUESTION ONE
(a) With the aid of a clearly labelled diagram, critically analyse
the implications of a small nation,
Mazyopa Republic, imposing a 100 percent ad valorem tariff on the
commodity of its
comparative disadvantage.
[30 Marks]
(b) Briefly describe the Leontief Paradox. What explanations were
drawn from the paradox
[20 Marks]
[TOTAL: 50 MARKS]
b.Leontief's paradox undermined the validity of the Heckscher Ohlin theory. Heckscher Ohlin theory predicted that trade patterns would be based on countries comparative advantage in certain factors of productionsuch as capital and labour. The Heckscher-Ohlin theory states that each country exports the commodity which usesits abundant factor intensively. The HO theory wasgenerally accepted on the basis of casual empiricism. Moreover, there wasn't any technique to test the HO theory until the input-output analysis was invented. the theory was madeThe first serious attempt to test by Professor Wassily W. Leontief in 1954. Leontief Paradox in economics basically means a country that produces fewer exports than imports yet it has a high capital in comparison to workers. The theory correlates with the Heckscher-Ohlin theory.
Leontief Paradox in economics basically means a country that produces fewer exports than imports yet it has a high capital in comparison to workers. The theory correlates with the Heckscher Ohlin theory. Leontief reached a paradoxical conclusion that the US the most capital abundant country in the world by any criterion exported labour-intensive commodities and imported capital intensive commodities. This result has come to be known as the Leontief Paradox.
Gains from trade
We now open up country A to foreign trade. To simplify matters, the analysis uses a partial equilibrium approach, showing the effects of trade on country A only, If we were to introduce country B, as in a general equilibrium approach, more sophisticated geometric tools would be needed.
We know that foreign trade is beneücial if the domestic opportunity cost is different from the international opportunity cost of wheat and cloth. A line TT is constructed to represent the international terms of trade, ie, the rate at which wheat trades for cloth in the international economy. Because it differs from the domestic opportunity cost it is constructed with a different slope to pp'. TT" also indicates how much cloth country A will produce when it is opened up to trade. It must be tangential to nn' because after trade, country A must still be somewhere on its production possibility curve, producing both wheat and cloth. The location is indicated by the new post-trade equilibrium e Country A has moved long the production possibility curve to e, where it is producing more cloth and less wheat. It has specialized in cloth at the expense of wheat because it is assumed to have a comparative advantage in cloth
Exports of cloth trade at the more favourable international opportunity cost represented by TT". TT" in determined by supply and demand conditions for wheat and cloth in country A and country B. To arrive at the post-trade equilibrium for country A, we move out along TT' until a point of tangency is reached with a higher indifference curve II', at e. At this point, country A's marginal rate of substitution in consumption (slope of I) is equal to the marginal rate of transformation in production (slope of nn), and is equal to the relative prices of wheat and cloth in international markets (slope of ). I represents a higher level of real income for country A. Foreign trade, which has led to specialization and exchange, results in a higher level of real income at the new post-trade equilibrium e'
Limitations of the theory
1. It is based on a number of unrealistic assumptions 2.It fails to measure real costs in terms of sacrifices, disutilities, etc 3.This approach ignored the changes in factor supplies 4.The opportunity cost approach failed to take into account the preference for leisure
Note
Have anwered part b. Can you specifically post for asking for question a. Thank you. Good luck.