Global Economic Issues
and Policies
First edition
Chapter 3
Sources of Comparative
Advantage
PowerPoint Presentation by Charlie Cook
Copyright © 2004 South-Western/Thomson Learning. All rights reserved.
1. What is the factor proportions explanation of
comparative advantage?
2. What is the Heckscher–Ohlin theory of trade?
3. How well does the factor proportions approach
explain trade patterns?
4. What is the relationship between trade and factor
prices?
5. What is the relationship between trade and real
income?
Copyright © 2004 South-Western/Thomson Learning. All rights reserved.
3–2
6. Is international production consistent with the
concept of comparative advantage?
7. How does economic growth affect trade patterns?
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3–3
The Factor Proportions Explanation of
International Trade
• Basic Factor Proportions Model
 Two nations that produce two identical goods using
two identical factors of production, or inputs, and the
same production technology.
• The Factor Proportions Approach
 Relative factor endowments of two nations and the
relative factor requirements of two goods their
residents trade determine where comparative
advantage lies.
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3–4
The Factor Proportions Explanation of
International Trade (cont’d)
• Factors of Production
 The resources firms utilize to produce goods and
services.
 Capital:
the physical equipment and buildings used to
produce goods and services.
 Labor
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3–5
Factor Endowments (Asset Differences)
• Relatively Labor-Abundant Nation
 In a two-country setting, the nation endowed with
more labor units per capital unit than the other
nation.
• Relatively Capital-Abundant Nation
 In a two-country setting, the nation endowed with
more capital units per labor unit than the other
nation.
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3–6
Factor Intensities (Process Differences)
• Relatively Labor-intensive Good
 In a two-good setting, the good with a production
process requiring more labor per capital unit than
the other good.
• Relatively Capital-intensive Good
 In a two-good setting, the good with a production
process requiring more capital per labor unit than
the other good.
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3–7
The Heckscher–Ohlin Theorem And
International Trade
• Heckscher–Ohlin Theorem
 A relatively labor-abundant nation will export a
relatively labor-intensive good, while a relatively
capital-abundant nation will export a relatively
capital-intensive good.
 A nation
that is relatively labor abundant will have a
comparative advantage in the production of the
relatively labor-intensive good
 A nation that is relatively capital abundant will have a
comparative advantage in the production of the
relatively capital-intensive good.
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3–8
Figure 3-1
Factor Endowments and the Production Possibilities Frontier
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3–9
Figure 3-2
Illustrating the Heckscher-Ohlin Theorem
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3–10
How Well Does the Factor Proportions
Approach Explain Trade?
• Leontief Paradox (Wassily Leontief)
 A finding that contradicted the Heckscher–Ohlin
theorem.
 Input-output research indicated that imports of the
United States, a relatively capital abundant nation,
were relatively more capital intensive than the
exports of the United States.
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3–11
How Well Does the Factor Proportions
Approach Explain Trade? (cont’d)
• Leontief Paradox (cont’d)
 Most subsequent studies show that the factor
proportions approach is rather weak at explaining a
nation’s trade pattern.
 Generalized factor proportions approaches do
predict trade patterns for particular sectors, such as
primary commodities and manufacturing.
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3–12
Table 3-1
Trade in Goods and Services of Selected Nations
Source: Data from UNCTAD, Handbook of Statistics, 2000.
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3–13
Table 3-1
Trade in Goods and Services of Selected Nations (cont’d)
Source: Data from UNCTAD, Handbook of Statistics, 2000.
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3–14
Trade, Factor Prices, and Real Income
• Factor Price Equalization Theorem
 Under the assumptions of the factor proportions
model, uninterrupted trade will bring about
equalization of goods prices and factor prices
across nations.
 Wages,
interest, and rental payments
 Real-world evidence indicates that trade may be
causing factor prices to become more equal, but
they have yet to equalize.
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3–15
Figure 3-3
Illustrating the Factor Price Equalization Theorem
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3–16
Trade And Real Income
• Stolper–Samuelson Theorem
 The theory that, in the context of the factor
proportions model, free trade raises the earnings of
the nation’s relatively abundant factors and lowers
the earnings of the relatively scarce factors.
• Magnification Principle
 A position of the Stolper–Samuelson theorem which
implies that the change in the price of a factor is
greater than the change in the price of the good that
uses the factor relatively intensively in its production
process.
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3–17
Trade And Real Income (cont’d)
• Implications of the Stolper–Samuelson Theorem
 Even though free trade may bring overall gains to a
nation, there are winners and losers.
 The owners of the relatively abundant factor are likely
to support free trade, while the owners of the
relatively scarce factor are likely to oppose free trade.
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3–18
International Production and Comparative
Advantage
• Value Added
 The revenue received by a producer less the cost of
the intermediate good it purchased.
• Outsourcing
 A strategy in which one organization hires another
organization to complete a particular stage of the
production process.
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3–19
International Production and Comparative
Advantage (cont’d)
• Contract Manufacturing
 A production strategy in which one organization
hires another organization to manufacture a good
under the hiring firm’s name and to the hiring firm’s
specifications.
• Kaleidoscopic Comparative Advantage
 The propensity for comparative advantage to
suddenly shift from one country to another.
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3–20
Economic Growth and International Trade
• Economic Growth
 Occurs when a nation experiences an increase in
available resources or a technological advance and
the nation’s production possibilities expands.
• The Rybczynski Theorem (T. M. Rybczynski)
 The theory that if a nation experiences an increase
in the amount of a resource, it will produce more of
the good that uses the resource relatively intensively
in its production process and produce less of the
other good.
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3–21
Figure 3-4
Illustrating the Rybczynski Theorem
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