Chapter 4
Comparative Advantage and Factor Endowments
◼ Outline
Introduction: The Determinants of Comparative Advantage
Modern Trade Theory
The Heckscher-Ohlin (HO) Trade Model
Gains from Trade in the HO Model
Trade and Income Distribution
The Stolper-Samuelson Theorem
The Specific Factors Model
Case Study: Comparative Advantage in a Single Natural Resource
Empirical Tests of the Theory of Comparative Advantage
Extension of the Heckscher-Ohlin Model
The Product Cycle
Case Study: United States-China Trade
The Impact of Trade on Wages and Jobs
Case Study: Do Trade Statistics Give a Distorted Picture of Trade Relations? The Case of the iPhone
3G
◼ What Students Should Know after Reading Chapter 4
Chapter 4 introduces the Heckscher-Ohlin and related models. The primary goal is to present the factor
proportions theory of the determinants of comparative advantage. A secondary goal is to understand the
effects of trade on the owners of factors of production. The Stolper-Samuelson and the specific factors
models allow students to consider the income distribution effects of trade. Students are walked through a
simple application that synthesizes the debates surrounding NAFTA and shows how these models can be
used to think about the distributional impacts of the agreement.
Product cycle theory is presented not as an alternative to comparative advantage but as an extension
of how comparative advantage might change over the life cycle of a product. This extension applies to
Chapter 4 Comparative Advantage and Factor Endowments 23
intra-firm trade as well, although the focus is on why a firm would choose foreign investment rather than
foreign trade. The goal in presenting both models is to put them into the context of traditional trade theory.
The discussion of intra-firm trade focuses on Dunning’s OLI (ownership-location-internalization) theory.
Ownership gives firms an asset that leads to a competitive advantage. Location refers to the fact that firms
will seek a production location that gives them advantages. Internalization is the firm’s attempt to capture
all the advantages of owning the asset. Firms decide whether to invest abroad or whether to trade from
their present location. Since comparative advantages may differ by location and firms are internationally
mobile, intra-firm trade does not contradict trade theory. The case study of U.S.-China bilateral trade
illustrates the discussion.
◼ Assignment Ideas
1. With the ratification and implementation of CAFTA in 2005, the Dominican Republic and a number
of small Central American countries now have a free trade agreement with the United States. Have
2. A more general assignment would be to ask students to pick a country, to identify its key resources
and its major exports and imports, and to decide whether the country’s trade pattern supports the
Heckscher-Ohlin Theorem. You can vary the nations over the class or let students pick a country
24 Gerber • International Economics, Sixth Edition
◼ Answers to End-of-Chapter Questions
1. According to the following table, which country is relatively more labor-abundant? Explain your
answer. Which is relatively more capital-abundant?
United States
Canada
Capital
40 machines
10 machines
Labor
200 workers
60 workers
2. Suppose that the United States and Canada have the factor endowments given in the table in
Question 1. Suppose further that the production requirements for a unit of steel is 2 machines
and 8 workers, and the requirement for a unit of bread is 1 machine and 8 workers.
a. Which good, bread or steel, is relatively capital-intensive? Labor-intensive? Explain your answer.
b. Which country would export bread? Why?
Answers:
3. Suppose that before trade takes place, the United States is at a point on its PPC where it produces
20 loaves of bread and 20 units of steel. Once trade becomes possible, the price of a unit of steel is 2
units of bread. In response, the United States moves along its PPC to a new point where it is
producing 30 units of steel and 10 loaves of bread. Is the country better off? How do you know?
4. Given the information in Questions 1 and 2, explain what happens to the returns to capital and labor
in each country after trade begins.
5. Suppose that there are three factors: capital, labor, and land. Bread requires inputs of land and labor,
and steel requires capital and labor.
a. Which factors are variable, and which are specific?
b. Suppose Canada’s endowments of land and capital are 10 capital and 100 land, and the
United States’ are 50 capital and 100 land. Which good does each country export?
c. How does trade affect the returns to land, labor, and capital in the United States and in Canada?
Answers:
c. In the United States, owners of land are hurt by trade, owners of capital benefit, and the effects
6. Describe the changes in production requirements and the location of production that take place over
the three phases of the product cycle.
Answer: In the first phase, all production is in high-income countries. The input requirements
7. Does intrafirm trade contradict the theory of comparative advantage? Why or why not?
8. General Motors is a U.S.-based multinational, but it is also one of the largest car manufacturers in
Europe and South America. How might Dunning’s OLI theory explain the trade-offs GM faced as it
decided whether to export to those two markets or to produce in them?
Answer: Transportation costs are significant in the auto sector, meaning that producing close to
9. Many domestically owned apparel manufacturers buy their garments overseas, sew their labels into
them, and then sell them abroad or back into the home market. What are some of the considerations
that a clothing manufacturer might go through to choose this strategy instead of producing at home
and exporting?
Answer: These firms perceive their asset to be their brand. This may involve some elements of
design (ordering specific output from foreign suppliers) but also could involve quality. It
10. Suppose Spain were to open its doors to a large number of unskilled Africans seeking to immigrate.
In general, what effects would you expect to see in Spain’s trade patterns and its comparative
advantage?