Question

1. International trade theory refers to the theories studying the gains and loss from international division of labor. In the history of the development of international trade, it gradually generates different yet equally important theories. Suppose labor is the only input needed to produce butter and potato. Please answer the question with the following numbers.

	butter	potato
Country Domino	1/5 unit of labor	1 unit of labor
Country Flamingo	1 unit of labor	3 units of labor

（1）According to Adam Smith’s absolute advantage theory, what will be the pattern of production and trade?

（2）According to David Ricardo ’s comparative advantage theory, what will be the pattern of production and trade?

（3）The production of butter needs 20 units of labor plus 4 units of land; the production of potato needs 1 units of labor plus 4 units of land. According to H-O theory, if Domino has 40 units of labor and 50 units of land while Flamingo has 120 units of labor and 200 units of land, what will be the pattern of production and trade?

Answer 1

1. According to Adam Smith's absolute advantage theory, a country should specialize in the commodity of its absolute advantage and trade it for commodity of its absolute disdvantage. According the given information, Country Domino has absolute advantage in both commodites. It is better in producing butter (requires less labor than Flamingo for 1 unit of butter) and it is better in producing potato too (requires less labor than Flamingo for 1 unit of potato). According to absolute advantage theory, there will be no trade in such a scenario.

2. According to Ricardo's comparative advantage theory, there is still a basis for mutually beneficial trade even if one country has absolute advantage in production of both countries. The country should produce that commodity where its absolute advantage is greater (this is the commodity of its comparative advantage) and trade it for commodity where its absolute advantage is smaller (this is the commodity of its comparative disadvantage).

Country Domino is 2 times better in producing butter (1/5 vs 1 unit of labor for each unit of butter) but 3 times better in producing potato (1 vs 3 units of labor for each unit of potato). Similarly, Country Flamingo is 2 times in worse in producing butter but 3 times worse in producing potato. Hence, Country Domino should produce potato and trade it for butter produced by Country Flamingo.

3. According to H-O theory, if a country is labor abundant then it should produce labor intensive goods and if a country is capital abundant it should produce capital intensive goods. According to the given information, potato is a labor intensive commodity (as it requires more labor to produce in both countries) and thus butter is a relative capital intensive country.

Country Flamingo has 3 times more labor (120/40) and 4 times more capital (200/50) than Country Domino. Therefore, it can be said that Country Domino is labor abundant while country Flamingo is capital abundant. Here we do not consider the absolute values of labor and capital but relative values. According to H-O theory, Country Domino should produce potato and Country Flamingo should produce butter.