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CHAPTER 3
SOURCES OF COMPARATIVE ADVANTAGE
CHAPTER OVERVIEW
This chapter examines the sources of a nation’s comparative advantage. Attention is then turned to the role
of transportation costs and their effect on the flow of trade under different economic assumptions..
The chapter begins with a discussion of how the Ricardian Theory assumption of labor as the sole factor of
1. Transportation costs affect the location of industry since firms recognize that transportation costs, in
addition to production costs, affect profitability. A firm achieves its best location when it can minimize
2. The international movement of products and factor inputs promote equalization of prices through
comparative advantage. The factor endowment theory suggests that a capital-abundant nation enjoys
relatively cheap capital. It thus specializes in and exports a capital-intensive good. This leads to
3. The Heckscher–Ohlin (factor-endowment) theory emphasizes factor endowments as the basis for
4. The Heckscher-Ohlin theory reasons that exports of products embodying large amounts of relatively
cheap, abundant factors makes those factors less abundant domestically. This leads to higher prices
5. The Leontief paradox questioned the applicability of the factor-endowment theory by concluding that
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the United States exported labor-intensive goods. This was the opposite conclusion that would be
6. Linder maintains that the factor-endowment theory is valid for trade in primary products, but that the
theory of overlapping demands best applies to trade in manufactured goods.
7. There appears to be some empirical support for the product life cycle theory in the area of
8. Adam Smith recognized that the division of labor is limited by the size of the market; world trade can
permit longer production runs for domestic manufacturers, which leads to increasing efficiency and
9. Inter-industry trade refers to the exchange between nations of products of different industries. Intra–
industry trade refers to two-way trade in a similar product. Among the determinants of intra-industry
trade are: (a) overlapping demand segments in trading countries, (b) the extent to which domestic
10. Industrial policy refers to a governmental strategy intended to revitalize, improve, and/or develop an
industry. Governmental policies intended to foster an industry’s development include loan guarantees,
research and development subsidies, low interest rate loans, trade protection, and the like. Creating
11. Governmental regulations imposed on domestic producers lead to higher production costs and a
decrease in competitiveness. Such regulation is a negative determinant on trade performance. Nations
12. Trade in business services is governed by factors such as: (a) employee skills and compensation
levels, (b) a firm’s ability to organize its employees in a productive manner, (c) availability of capital
13. a. Sweden—P = $15, Q = 600; Norway—P = $30, Q = 600. Sweden has the comparative advantage in
calculators.
b. P = $22.50 and 600 calculators are traded at that price. Sweden—Qs = 900, Qd = 300; Norway—Qs
14. Innovations such as containerization have generally lowered transportation costs. This has made
foreign exports more competitive with products that are produced domestically. However,
transportation costs have begun to rise recently and thus domestic products and those foreign