Question

QUESTION 1

(a) Using the example of two nations, explain the effect of international trade on relative factor prices and income within both nations.

(b) Using the example of two nations, explain the effect of international trade on the difference in factor prices between the nations.

Answer 1

A.If two nations come into trade, the more comparatively advantage countries will export their products to the comparatively disadvantage country. Through this the efficiency of the production in both the countries will increase. Thus the demand for each commodity increases in the international market. The high factor price country’s cost of production will be very high comparing with others. So this country will import the high cost products from the other country. The difference in factor prices will also make the application of comparative cost advantage theory. If there are two nations, US and India. US having comparatively advantage in the production of wine, at low cost. The production of wine in India is high cost and also comparatively disadvantage. On the other hand, India has the capacity to produce silk with low cost. But India produced wine using high cost. Thus US will export the low cost production of the wine to India and India export low cost silk to US.

B.The ricardian model used to explain the relative price of factors in international trade. There is an absolute cost difference among the factors of production. The relative price will change according to the production cost. Low production cost having low relative price. The relative cost of the factors in both US and Africa will differ each other. The relative price of cake in US is lesser than cake in Africa. Thus Africa will import more cake from US. This make US advantage in the production of cake.