Chapter 4: Comparative Advantage and Factor Endowments
Class Notes: these count for 1% of your total grade
1. Definitions
Magnification Effect: The magnification effect refers to the concept that changes in output
prices lead to disproportionately larger changes in factor prices. This principle is often used
to explain how international trade influences income distribution within a country.
Intrafirm trade: Intrafirm trade is the exchange of goods and services that occurs within the
same multinational corporation across different countries. This type of trade is common in
industries where firms have global supply chains and distribute production among
subsidiaries in multiple nations.
Off-shoring: Off-shoring refers to the relocation of business operations or services from one
country to another, typically to take advantage of lower labor costs, tax benefits, or other
economic efficiencies. It involves shifting production or service jobs abroad while still being
managed by the original company.
Outsourcing: Outsourcing is the practice of contracting out business processes, production, or
services to an external company rather than handling them in-house. This can occur
domestically or internationally, depending on cost efficiency and expertise availability.
2. The Stolper-Samuelson Theorem predicts that income accrues how? (Hint: you’ll need to
involve trade and factors of production).
Stolper-Samuelson Theorem and Income Accrual
The Stolper-Samuelson Theorem predicts that international trade will affect income distribution
among factors of production. Specifically:
When a country engages in trade, the price of the good that uses its abundant factor intensively
will increase.
The increase in the price of this good raises the income of the factor used intensively in its
production.
Conversely, the income of the factor used less intensively will decline.
As a result, trade benefits owners of the relatively abundant factor while potentially harming
owners of the relatively scarce factor.
3. According to the Specific Factor Model, how do we determine which countries export
what good? Also, how does income accrue to the factors of production?
According to the Specific Factor Model:
- A country exports goods that use its relatively abundant factors intensively and imports
goods that use its scarce factors intensively.
- Factors of production specific to the exporting industry will benefit from trade, as the
demand for these factors increases with higher output levels.
- Conversely, factors specific to the import-competing industry may suffer income losses,
as production in these industries contracts due to foreign competition.
- Mobile factors, such as labor, may reallocate across industries, but in the short run, those
tied to specific sectors experience income shifts before adjustments can be made.
- Over time, as factor mobility increases, wage disparities between industries may be
reduced, and overall efficiency gains from trade will lead to higher economic growth.
4. Identify areas A, B, and C and also identify which type of country is on the left and right
panels.
Area A: Represents the production possibilities frontier (PPF) before trade.
Area B: Represents the production and consumption points after trade.
Area C: Represents the gains from trade, showing how consumption possibilities expand beyond
initial domestic production capabilities.
The left panel represents a labor-abundant country, while the right panel represents a capital-
abundant country.
5. Does trade have any effect on the number of jobs in the medium- and long-run and wage
inequality?
In the Medium Run:
o Trade does not necessarily lead to job losses overall but causes shifts in
employment between industries.
o Some workers may experience displacement if they are tied to import-competing
sectors, leading to short-term unemployment or transition periods.
In the Long Run:
o Trade increases overall efficiency, leading to economic growth and job creation in
export-oriented industries.
o Technological advancements and sectoral shifts drive employment redistribution.
Effect on Wage Inequality:
o Trade tends to increase wage inequality in developed countries, as it raises the
return to capital and high-skilled labor while reducing wages for low-skilled
workers.
o In developing countries, trade can reduce wage inequality by increasing demand
for low-skilled labor, which is relatively abundant.
Overall, trade influences income distribution and labor dynamics differently depending on factor
endowments and the structure of the economy.