Question

IV.Questions (36%) 1. Explain the main idea of H-O theorem. (6%) 2. What is increasing returns to scale? Draw a graph to explain the trade based on increasing returns to scale (10%) 3. Draw a graph to explain the effect of import quota (8%) 4. The production possibility frontiers of nation 1 shown in Fig. nation 1 is labor abundant and export X . P4 is the equilibrium price of autarky in nation 1, Pw and P are the world prices. (12%) 1) analyze the factor intensity of X and Y, why? 2) what is the advantage of nation 1, why? 3) explain the points of A,B, T, E. 4) explain the gains from exchange and specialization. price and productivity of labor. Nation 1 Y 100 80 F PA.. 60 40 Pg= Pw=1 20 Pw=1 X 150 130 110 50 70 30 O 10 3 90

Answer 1

(a) The H-O model says that if a country has competitive advantage in capital, they will export capital abundant goods. If they have excess labour in their economy, they will,export labour intensive products. Each country exports that good that it produces relatively better than the other country. In this model, a country’s advantage in production arises from its relative factor.

The H-O model assumes that the two countries have same technologies to produce the same product, they have the same production function available with them. The only difference that exist between them is that they have different endowments of factors of production. We assume that China and India have abundant labour in their country, that is the reason they export those products which are labour intensive while US and Japan have updated technological machinery through which they export capital intensive products across the world. Suppose Maruti Suzuki private limited produces car, they get cheaper engine of car in Japan which is a automobile exporter across the world and they get the different parts of the car in USA and they get cheaper labour in China to assemble these all. Maruti suzuki will import engine and other parts in china and assemble there so that they reduce the overall cost of the company.

(2) Increase in economies of scale basically means that if in long run company increases the output of the firm that must be done at the case when input cost increased is less than output increased. You can refer to the diagram of SRAC1 and SRAC2 which are company shoryt run cost curve. Here cost falls when output rises. These situation occurs at the time of initial phase of the company. As they have new machinery with updated technology, they can reduce the cost if they increase the quantity manufactured. Once the machinnery gets old, the depreciation cost is so high that it becomes problematic to cover the input cost.

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(3) Without quotas the market price is P world and domestic prices are higher and quantity of imports is Q4-Q1. When the government imposes import quota prices are raised so that domestic supply increased rightward. Import decreased to Q2-Q3 instead of Q1-Q4.(4)

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• Factor intensity can be used in economics by which factors of production can be compared across industries. Labour is abundant in country 1 and exports X where you exports the labour abundant products. Capital is less in the nation.
• Advantage of nation 1 is labour intensive products which they can produce and export. Given the PPF curve, we have at every point, production of produce X is more than product Y. Product X can be produced with more labour and less capital, that is the reason they are producing more of product X.
• Point is the optimal point if the budget line of the consumer is dashed one. That line is tangent to the PPF curve at point A. Point B is the optimal point if the budget line is the straight line of which point B is. C and D are unattianable as they lie outside the PPF curve.
• The gains from exchange is for nation 1 where they export the products in which they have competitive advantage. The country which imports from nation1 may be a capital intensive firm which imports labour intensive products. Both countries are getting benefit with this and operating at their optimal point.