Question

Draw diagrams and explain in detail.

a. Compare the Theory of Comparative Advantage with the Neo Classical Theory.

Explain the Autarky and Free Trade situations in both; give diagrams and explain what happens when the country moves from Autarky to Free Trade.

b. Are there any gains from trade in both these theories? If yes, please give details.

Answer 1

1) We compare neoclassical and classical theories of outsourcing.

• The former is based on an improved international division of labor and predicts a rise in the return to skill
• . This contrasts with the classical model, that emphasizes the distribution of income between labor and capital and its implications for investment and economic growth.
• But the classical model needs improvisation in the contemporary world
• International capital mobility, wage stagnation and vertical specialization indicate the direction of trade depends on both absolute and comparative advantage. Moreover, the classical perspective must be modified to allow for the seapage of profits into financial assets.

2) Autarky, an economic system of self-sufficiency and limited trade. A country is said to be in a complete state of autarky if it has a closed economy, which means that it does not engage in international trade with any other country.

Autarkic systems are the opposite of free trade systems, which encourage the free flow of goods and services.

• Suppose two countries, the US and France, move from autarky to free trade. If the US has the comparative advantage in cheese production then  which implies . When the two countries move to free trade, price ratio will lie somewhere between the autarky price ratios. This means that  rises in the US when moving from autarky to free trade while falls when moving to free trade.
• The other major change that occurs is that the US specializes in cheese production while France specializes in wine production. This means that real wages in free trade for wine workers in the US need not be determined  since the US will no longer have any wine workers. Similarly for real wages for cheese worker in France.

3) Autarky implies that - The gains are larger the more the price differs from its autarkic level. A country can increase its utility by trading and thus gains from trade at the national level.

Free trade - It drives economic growth, enhanced efficiency, increased innovation, and the greater fairness that accompanies a rules-based system. These benefits increase as overall trade—exports and imports—increases. Free trade increases access to higher-quality, lower-priced goods. eg how it happened in india after LPG in 1991