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 trade flows.
The chapter begins with a discussion of the factor endowment theory of trade as developed by Eli Heckscher
After completing this chapter, students should be able to:
• Discuss the nature and operation of the theory of factor endowments.
• Identify the predictions of the theory of overlapping demands.
BRIEF ANSWERS TO STUDY QUESTIONS
1. Transportation costs affect the location of industry since firms recognize that transportation costs in
2. 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 increased demand for capital,
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which forces up the price of capital and thus the price of the capital-intensive good. The opposite occurs
in the capital-scarce country. The basis for further specialization and trade ceases when the capital
prices and product prices in each nation equate.
4. The Heckscher-Ohlin theory reasons that exports of products embodying large amounts of relatively
5. The Leontief paradox questioned the applicability of the factor-endowment theory by concluding that the
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.
8. Adam Smith recognized that the division of labor is limited by the size of the market; world trade can
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
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,
11. Governmental regulations imposed on domestic producers lead to higher production costs and a decrease
12. Trade in business services is governed by factors such as: (a) employee skills and compensation levels,
13. a. Sweden—P = $15, Q = 600; Norway—P = $30, Q = 600. Sweden has the comparative advantage
in calculators.