Question

2. Explain the following theorems/phrases in the context of international trade theory.

a. Absolute Advantage

b. Comparative Advantage

c. Opportunity cost

d. Factor-Price Equalization Theorem

e. Factor Price Insensitivity Theorem

f. Stolper-Samuelson Theorem

g. The Leontief Paradox

h. Increasing returns to scale

i. Economies of scale

j. Index of Intra-Industry Trade

k. Love of variety

Answer 1

a. Absolute advantage: It is when a producer can produce a service or good in larger/greater quantity for the equal or same cost, or the same quantity at lesser/lower cost, than other producers. It can be the base for big gains from trade among producers of various goods with different absolute advantages.

b Comparative advantage: It is an economy's ability to produce or make a particular service or good at a lower/ lesser opportunity cost than its trading partners. It suggests that countries will do/engage in trade with each another, exporting the goods and services that they have a relative advantage in.

c Opportunity cost: The cost of producing a good or commodity in value/ terms of the alternative production that has to forgo for producing that particular good or commodity in context.

D Factor price equalization was given by Paul A. Samuelson in the year 1948,and it states that the prices of identical factors of production, such as the wage rate, or the rent of capital, will be equalized across countries as a result of international trade in commodities

E The theorem simply states that when the prices of the output goods and services are equalized between countries as they move to a state of free trade, then the prices of the input factors i.e. capital and labor will also be equalized between countries.

F The Stolper–Samuelson theorem: It is a basic theorem in Heckscher–Ohlin trade theory. It describes the relationship between relative prices of output and relative factor rewards—specifically, real wages and real returns to capital.

G Leontief's paradox: A country with a higher capital per worker has a lower capital/labor ratio in exports than in imports. Leontief interpreted from this result that the U.S. should adapt its competitive policy to match its economic realities.

H Increasing returns to scale It means that production at a larger scale or more output can be achieved at a lower cost meaning with economies or savings.

I Economies of scale. It means that production at a larger scale (more output) can be achieved at a lower cost with economies or savings. Just for this reason, economies-of-scale models were often used to explain trade among countries like the EU, US and japan

J Index of Intra-Industry Trade: A measure of the intra-industry trade that takes place between countries is the Grubel-Lloyd (GL) index. For example. If a country only exports or imports good C1 e.g. sugar then the GL index for that sector is equal to 0.

K Love of Variety: This approach assumes that each consumer has a demand for multiple varieties of a product over time. Example of this would be restaurant meals. Each consumer is assumed to have different preferences over these feature.