QUESTION 1 [25 marks]
(i) Identify the commodity in which Lesotho and Botswana have an absolute advantage and absolute
disadvantage [4 marks]
The principle of absolute advantage refers to the ability of a party to produce a good or service more
efficiently than its competitors. Adam Smith first described the principle of absolute advantage in the
context of international trade, using labor as the only input.
Lesotho has absolute advantage in the production of both wool and beef.
Botswana has a absolute disadvantage in the production of both wool and beef.
(ii) Indicate the commodity of each nation’s comparative advantage and disadvantage. Show your
workings. [6 marks]
Output Lesotho Botswana
Wool [ ton/hr] 4 [ 4/3=1,33] 1 [1/2=0.5]
Beef[ ton /hr] 3 [3/3=1] 2 [2/2=1]
Lesotho has a comparative advantage in the production of wool as it sacrifices 1 beef to produce 1,33
wool where as Botswana has a comparative disadvantage in the production of wool as it sacrifices 1
beef to produce only 0,5 wool. However Botswana has a comparative advantage in the production of
beef as it only sacrifices 0,5 wool to produce 1 beef whilst Lesotho sacrices 1,33 wool to produce the
same that is 1 beef.
(iii) If Lesotho exchanges 4W for 4B with Botswana,
(a) How much does Lesotho gain in terms of beef? [2 marks]
It will gain an additional 1 ton of beef.
(b) How much does Botswana gain in terms of beef? [2 marks]
Botswana will gain an additional 2 ton of beef.
(c) What is the range of mutually beneficial trade? [3 marks]
The range of mutual beneficial trade is: 1<2<4
QUESTION 1B
Briefly explain the theories of absolute and comparative advantage, highlighting any similarities
and differences between the two. [8 marks]
According to Adam Smith, trade between two nations is based on absolute advantage. When one nation
is more efficient than (or has an absolute advantage over) another in the production of one commodity
but is less efficient than (or has an absolute disadvantage with respect to) the other nation in producing
a second commodity, then both nations can gain by each specializing in the production of the
commodity of its absolute advantage and exchanging part of its output with the other nation for the
commodity of its absolute disadvantage.
According to the law of comparative advantage, even if one nation is less efficient than (has an absolute
disadvantage with respect to) the other nation in the production of both commodities, there is still a
basis for mutually beneficial trade. The first nation should specialize in the production and export of
the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative
advantage) and import the commodity in which its absolute disadvantage is greater (this is the
commodity of its comparative disadvantage).
Differences: The theory of absolute advantage goes a step further to emphasize that if one nation has
an absolute advantage in the production of both goods trade is not mutually beneficial however with
, regard to the theory of comparative advantage trade is still beneficial even if one nation has absolute
advantage in the production of both goods.
Similarities: Both theories believe any economy has limited resources and there will be opportunity
cost for making any product.
QUESTION 2 [25 marks]
QUESTION 2A
FIG 1
You are given the following hypothetical scenario: Two countries, lunchi and Punchi. Lunchi is a capital
abundant country and Punchi is a labour abundant country. Both countries consume and produce iron
and leather. Iron is capital intensive and leather is labour intensive. Using a graphical representation of
Punchi, explain the two components of the gains from trade.
QUESTION 2B
Assume two countries, Malawi and Japan, Malawi is labour abundant, and Japan is capital
abundant. Assume further that Good A is labour intensive and good B is capital intensive.
Explain how trade between the two countries will affect factor prices and how income will
be distributed in the two countries. [10 marks]
The Factor price Equalization Theorem or the H-O-S Model
This theorem says that international trade will cause the wage rate of homogenous labour and the
rental price of capital (interest rate) to be the same in all trading nations (Malawi and Japan). Both
relative and absolute factor prices will be equalised. International trade will bring about equalization in
the relative and absolute returns to homogeneous factors across nations. As such, international trade
is a substitute for the international mobility of factors.
The H-O-S is derived from the H-O and holds if the H-O holds thus, it shares the same assumptions as
the H-O. This implies of this is that international trade will cause the wages of homogeneous labor, (i.e,
(i) Identify the commodity in which Lesotho and Botswana have an absolute advantage and absolute
disadvantage [4 marks]
The principle of absolute advantage refers to the ability of a party to produce a good or service more
efficiently than its competitors. Adam Smith first described the principle of absolute advantage in the
context of international trade, using labor as the only input.
Lesotho has absolute advantage in the production of both wool and beef.
Botswana has a absolute disadvantage in the production of both wool and beef.
(ii) Indicate the commodity of each nation’s comparative advantage and disadvantage. Show your
workings. [6 marks]
Output Lesotho Botswana
Wool [ ton/hr] 4 [ 4/3=1,33] 1 [1/2=0.5]
Beef[ ton /hr] 3 [3/3=1] 2 [2/2=1]
Lesotho has a comparative advantage in the production of wool as it sacrifices 1 beef to produce 1,33
wool where as Botswana has a comparative disadvantage in the production of wool as it sacrifices 1
beef to produce only 0,5 wool. However Botswana has a comparative advantage in the production of
beef as it only sacrifices 0,5 wool to produce 1 beef whilst Lesotho sacrices 1,33 wool to produce the
same that is 1 beef.
(iii) If Lesotho exchanges 4W for 4B with Botswana,
(a) How much does Lesotho gain in terms of beef? [2 marks]
It will gain an additional 1 ton of beef.
(b) How much does Botswana gain in terms of beef? [2 marks]
Botswana will gain an additional 2 ton of beef.
(c) What is the range of mutually beneficial trade? [3 marks]
The range of mutual beneficial trade is: 1<2<4
QUESTION 1B
Briefly explain the theories of absolute and comparative advantage, highlighting any similarities
and differences between the two. [8 marks]
According to Adam Smith, trade between two nations is based on absolute advantage. When one nation
is more efficient than (or has an absolute advantage over) another in the production of one commodity
but is less efficient than (or has an absolute disadvantage with respect to) the other nation in producing
a second commodity, then both nations can gain by each specializing in the production of the
commodity of its absolute advantage and exchanging part of its output with the other nation for the
commodity of its absolute disadvantage.
According to the law of comparative advantage, even if one nation is less efficient than (has an absolute
disadvantage with respect to) the other nation in the production of both commodities, there is still a
basis for mutually beneficial trade. The first nation should specialize in the production and export of
the commodity in which its absolute disadvantage is smaller (this is the commodity of its comparative
advantage) and import the commodity in which its absolute disadvantage is greater (this is the
commodity of its comparative disadvantage).
Differences: The theory of absolute advantage goes a step further to emphasize that if one nation has
an absolute advantage in the production of both goods trade is not mutually beneficial however with
, regard to the theory of comparative advantage trade is still beneficial even if one nation has absolute
advantage in the production of both goods.
Similarities: Both theories believe any economy has limited resources and there will be opportunity
cost for making any product.
QUESTION 2 [25 marks]
QUESTION 2A
FIG 1
You are given the following hypothetical scenario: Two countries, lunchi and Punchi. Lunchi is a capital
abundant country and Punchi is a labour abundant country. Both countries consume and produce iron
and leather. Iron is capital intensive and leather is labour intensive. Using a graphical representation of
Punchi, explain the two components of the gains from trade.
QUESTION 2B
Assume two countries, Malawi and Japan, Malawi is labour abundant, and Japan is capital
abundant. Assume further that Good A is labour intensive and good B is capital intensive.
Explain how trade between the two countries will affect factor prices and how income will
be distributed in the two countries. [10 marks]
The Factor price Equalization Theorem or the H-O-S Model
This theorem says that international trade will cause the wage rate of homogenous labour and the
rental price of capital (interest rate) to be the same in all trading nations (Malawi and Japan). Both
relative and absolute factor prices will be equalised. International trade will bring about equalization in
the relative and absolute returns to homogeneous factors across nations. As such, international trade
is a substitute for the international mobility of factors.
The H-O-S is derived from the H-O and holds if the H-O holds thus, it shares the same assumptions as
the H-O. This implies of this is that international trade will cause the wages of homogeneous labor, (i.e,
