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 and
Bertil Ohlin. The discussion considers the process of factor-price equalization and the impact of trade on the
distribution of income. Next examined is empirical evidence regarding the factor endowment theory. The chapter
also considers the role of economies of scale, overlapping demands, intraindustry trade, and product cycles.
The principle of comparative advantage is then examined in a dynamic framework. Special emphasis is given to the
role of industrial policy and environmental regulatory policies.
Finally, the chapter considers the effects of transportation costs on international trade patterns. It is noted that
transportation costs tend to reduce the volume of international trade by increasing the prices of traded goods.
After completing this chapter, students should be able to:
• Discuss the nature and operation of the theory of factor endowments.
BRIEF ANSWERS TO STUDY QUESTIONS
1. Transportation costs affect the location of industry since firms recognize that transportation costs in addition to
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, which forces
3. The Heckscher-Ohlin theory emphasizes factor endowments as the basis for trade, while Ricardian theory
stresses the role of labor productivity.
4. The Heckscher-Ohlin theory reasons that exports of products embodying large amounts of relatively cheap,
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 permit
9. Interindustry trade refers to the exchange between nations of products of different industries. Intraindustry
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
11. Governmental regulations imposed on domestic producers lead to higher production costs and a decrease in
12. Trade in business services is governed by factors such as: (a) employee skills and compensation levels, (b)
13. a. Sweden—P = $15, Q = 600; Norway—P = $30, Q = 600. Sweden has the comparative advantage in
calculators.