International Economics
By Robert J. Carbaugh
9th Edition
Chapter 3 (A): Sources of
Comparative Advantage
Copyright ©2004, South-Western College Publishing
Why relative price differentials?
Factor endowment theory (Heckscher-Ohlin)
Comparative advantage is explained
entirely by different national supply
conditions, especially resource
endowments
Nations export products that use inputs
which are relatively abundant (cheap) at
home, and import products which need
inputs which are relatively scarce
(expensive) at home
Carbaugh, Chap. 4 2
Why relative price differentials?
Factor endowment theory (Heckscher-Ohlin)
the theory highlights the role of nations' resource
endowments as the key determinant of comparative
advantage.
Brazil exports coffee because it has an abundance
of the soil and climatic conditions required for
coffee's production; the United States and Canada
export wheat because they are endowed with an
abundance of temperate-zone land, which is well
suited for wheat production; and India and China
are huge exporters of shoes and garments because
they are heavily endowed with labor.
Carbaugh, Chap. 4 3
Why relative price differentials?
Factor endowment theory: assumptions
Nations all have the same tastes and
preferences (same indifference curves)
They use factor inputs which are of uniform
quality
They all use the same technology
Factors are mobile across industries
No or little transportation costs
Carbaugh, Chap. 4 4
Why relative price differentials?
Factor endowment theory: assumptions
a nation will export that commodity for
which a large amount of the relatively
abundant (cheap) input is used.
It will import that commodity in the
production of which the relatively scarce
(expensive) input is used.
Carbaugh, Chap. 4 5
Why relative price differentials?
Factor endowment theory: assumptions
Carbaugh, Chap. 4 6
Factor endowment model
Factor endowment theory
The U.S. capital labor ratio equals 0.5 (100
machines/200 workers = 0.5).
In China, the capital labor ratio is 0.02 (20
machines/1,000 workers =0.02).
Since the U.S. capital labor ratio exceeds China's
capital labor ratio, we call the United States the
capital-abundant country and China the capital
scarce country.
On the other side of the coin, China is called the
labor-abundant country and the United States the
labor-scarce country.
Carbaugh, Chap. 4 7
Factor endowment model
Factor endowment theory: implications
Factor price equalization
The shift within each nation towards use of cheaper
factors, and away from expensive ones, leads to more
equal factor prices (if factors are mobile)
A nation with trade finds output expanding
in its comparative-advantage industry,
which uses a lot of the cheap, abundant
factor.
As a result of the rise in demand for the
abundant factor, its price increases.
Carbaugh, Chap. 4 8
Factor endowment model
Factor endowment theory: implications
At the same time, the expensive, scarce factor
is being released from the comparative-
disadvantage industry; producers will not be
induced to employ this factor unless its price
falls.
Each nation experiences a rise in the price of
the abundant factor and a fall in the price of
the scarce factor.
Trade therefore leads toward an equalization
of the relative factor prices in the two trading
partners.
Carbaugh, Chap. 4 9
Factor endowment model
Factor endowment theory: implications
Distribution of income
Trade changes domestic distribution of income as demand for different factors
changes
The factor-endowment theory states that the export of
commodities embodying large amounts of the relatively cheap,
abundant factors makes those factors less abundant in the
domestic market.
The increased demand for the abundant factor leads to an
increase in its return.
At the same time, returns to the factor used intensively in the
import competing product (the scarce factor) decrease as its
demand falls.
The increase in the returns to each country's abundant factor
thus comes at the expense of the scarce factor's returns.
Carbaugh, Chap. 4 10
Factor endowment model
Factor endowment theory: implications
Distribution of income
In theory, increased trade could worsen inequalities
in wages even while increasing national income.
The U.S. economy, for example, has a relative
abundance of skilled labor, and so its comparative
advantage is in producing skill-intensive goods.
The factor-endowment model suggests that the
United States will tend to export goods requiring
relatively large amounts of skilled labor and import
goods requiring relatively large amounts of unskilled
labor
Carbaugh, Chap. 4 11
Factor endowment model
Factor endowment theory: implications
Distribution of income
International trade in effect increases the supply of
unskilled labor to the [Link], lowering the wages of
unskilled American workers relative to those of skilled
workers.
Skilled workers- who are already at the upper end of the
income distribution-find their incomes increasing as
exports expand, while unskilled workers are forced into
accepting even lower wages in order to compete with
imports.
According to the factor endowment theory, then,
international trade can aggravate income inequality, at
least in a country such as the United States where skilled
labor is relatively abundant.
Carbaugh, Chap. 4 12
Factor endowment model
Factor endowment theory: implications
Distribution of income
The notion that the abundant factor gains from free trade
and that the relatively scarce factor loses is founded on
the assumption that resources are completely mobile
among industries within a country and completely
immobile among countries.
In the short run, however, the mobility of factors may be
imperfect and the results quite different.
Carbaugh, Chap. 4 13
Distribution of income
Does trade worsen inequality?
Trade theory suggests that countries with
abundant skilled labor will import goods which are
made with unskilled labor
Equilibrium wage ratios for skilled/unskilled labor
are affected by trade and technology change,
immigration, and education & training
Evidence suggests that trade contributes
relatively little to wage inequality, compared to
technological change and other factors; better
education and training are potential solutions
Carbaugh, Chap. 4 14