International Trade Assignment Fall 2015

Page3assignment 1 International Trade Fall 2015 9172015 1029 Amin

Analyze the provided international trade economy scenarios involving two nations with different resource endowments, productivity, and wages. Construct production possibility frontiers, evaluate comparative advantages, and consider the effects of trade. Address the impact of exchange rates and wage disparities on trade benefits, and explore how pricing and wage changes influence market equilibrium. Discuss the assumptions of the Ricardian model and its empirical validity in explaining international trade patterns.

Paper For Above instruction

International trade theory provides vital insights into how nations with diverse resource endowments, productivity levels, and wage structures can engage in mutually beneficial exchanges. This analysis explores the principles of comparative advantage, production possibility frontiers, and market equilibrium through practical scenarios involving multiple countries, their productivity outputs, wages, and exchange rates. The core objective is to understand whether trade benefits arise under various conditions, especially considering differences in living standards, productivity, and wages, and how these factors influence global economic interactions.

Part 1: Production Possibility Frontiers and Comparative Advantage

The initial scenario involves two nations, Nation 1 with 100 laborers and Nation 2 with 200 laborers, producing bicycles and shoes. The productivity data in terms of units per laborer per day guide the construction of each nation's production possibility frontier (PPF). Drawing the PPF involves plotting the maximum attainable output of bicycles (vertical axis) against shoes (horizontal axis). For Nation 1, if each laborer produces a certain number of bicycles and shoes, the PPF slope indicates the opportunity cost of shifting resources from one good to another.

Similarly, Nation 2's PPF reflects its higher labor count and differing productivity rates. The steeper the frontier, the higher the opportunity cost of producing one good over the other. The comparative advantage is determined by which country has a lower opportunity cost for each good. For instance, if Nation 1 sacrifices fewer shoes per bicycle than Nation 2, then Nation 1 has a comparative advantage in bicycles; the same logic applies for shoes.

When productivity is consistent across both nations, the possibility for beneficial trade emerges, especially as each country specializes in the good which it produces relatively more efficiently. This specialization leads to an overall increase in total output, allowing both nations to consume beyond their individual PPFs through trade.

Part 2: Impact of Productivity and Wages on Trade Patterns

In the scenario where one laborer in Nation 2 can produce 30 units of shoes or bicycles per day, productivity increases significantly. This change affects the comparative advantage analysis, possibly shifting benefits towards Nation 2, depending on the relative efficiencies now apparent. Market prices and wages further influence trade dynamics. With wages set at 40 euros in France and $100 in the US, the prices of goods per unit reflect the costs of production under competitive markets, with wages divided by productivity per worker.

Given these wages, France's unit costs for wine and cheese, and similarly the US's, determine the relative prices. If wages are low in the low-productivity country, it could, in theory, dominate trade due to cheaper costs; however, this ignores productivity differences, which are often more decisive.

Crucially, the theory of comparative advantage asserts that the country with the lower opportunity cost of producing a good should specialize and export that good. Wages affect the absolute cost but not the relative cost, which determines comparative advantage. Therefore, even with low wages, if productivity is low, the country may still not be competitive in certain goods.

Part 3: Prices, Exchange Rates, and Equilibrium

When wages are fixed but exchange rates vary, the relative prices of goods in different currencies fluctuate, influencing trade balances. If wages in France and the US are unchanged but the exchange rate adjusts, prices expressed in one currency will change, affecting competitiveness. For instance, if the euro weakens against the dollar, French exports become cheaper in the US, potentially boosting France's exports despite static wages.

Conversely, fixed exchange rates imply that wage and price adjustments occur via other mechanisms. If market prices deviate from costs of production, disequilibrium occurs, prompting wages and prices to adjust over time in response to supply and demand forces, restoring equilibrium.

Consistent with the theory of comparative advantage, if markets are perfectly competitive, relative prices must reflect opportunity costs derived from productivity differences, leading to optimal trade patterns. Any disparity suggests potential for adjustments via exchange rates or wage changes.

Part 4: Marginal Productivity and Trade in Goods

The third problem examines the marginal productivity of labor in US and Great Britain for wheat and cloth, estimating the marginal costs based on wages and output per laborer. If the wage in the US is $6 per day, the marginal costs in terms of labor relate directly to the inverse of productivity. The lower the marginal cost, the more competitive the country is in that good.

With this information, we evaluate whether the US should import wheat or cloth from Britain, based on comparative advantage, which hinges on the lowest opportunity cost derived from productivity and wage data. Price calculations in both domestic and foreign currencies, considering exchange rates, inform whether trade is feasible and profitable. For instance, if the US can produce wheat at a lower effective cost than Britain, it should export wheat to Britain.

Changes in exchange rates influence international competitiveness, and the ranges of exchange rates consistent with comparative advantage can be derived by comparing relative prices and productivity.

Part 5: The Ricardian Model and Empirical Validity

The Ricardian model relies on assumptions such as constant returns to scale, perfect competition, and productivity differences across countries. Empirical testing involves comparing model predictions to real-world trade patterns, often through cross-country data and regression analysis. While the model explains many trade flows driven by productivity differences, it oversimplifies by ignoring factors like transportation costs, economies of scale, and other market imperfections.

Thus, the Ricardian model provides a foundational understanding but is insufficient alone to explain all international trade phenomena. More comprehensive models incorporating multiple factors and adjustments tend to offer better real-world applicability.

In conclusion, the principles of comparative advantage derived from productivity and opportunity costs are central to understanding trade benefits. However, market realities such as fluctuating wages, exchange rates, and cost structures require nuanced analysis beyond the Ricardian framework. Recognizing these complexities allows policymakers and economists to better predict and influence trade outcomes.

References

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