Chapter 4: Comparative Advantage and Factor Endowments

Class Notes: these count for 1% of your total grade

1. Definitions
Comparative productivity advantage: A country has a comparative productivity advantage in
a good, or simply a comparative advantage, if its opportunity costs of producing a good are
lower than those of its trading partners.
Magnification Effect: This effect shows that a change in output prices has a magnified effect
on factor incomes. For example, if the price of an export good rises by 50 percent, the
incomes earned by the intensively used factors in that sector rise by more than 50 percent.
Intrafirm trade: This is international trade between a parent company and a foreign-owned
affiliate.
Off-shoring: This is defined as the movement of some or all of a firm’s activities to a
location outside the home country
Outsourcing: This is the reassignment of activities to another firm, either inside or outside the
home country.

2. The Hecksher-Ohlin model of trade relies on what two aspects to determine which
country exports which good?
The Heckscher-Ohlin (HO) trade model relies on two primary aspects to determine a
country's comparative advantage and subsequent exports:
 Factor Endowments (or factor abundance/ scarcity): This refers to the observation
that nations are endowed with different levels of each input (factors), such as labor,
capital, and resources, available within a country,.
 Factor Intensity (or technology): This relies on the observation that each output has a
different technology for its production and requires different combinations and levels
of the various inputs.
The theory also concludes that a country's comparative advantage lies in the production of
goods that intensively use factors that are relatively abundant in that country

3. Mathematically, what does your answer from 2 look like (i.e. no numbers are needed
just ratios)?
The determination relies on comparing the ratios of factor endowments between countries and
the ratios of factor usage (intensity) between goods. If we consider only capital (K) and Labor
(L):
 Relative factor abundance: The United States (us) is the relatively capital-abundant
country compared to Canada (can) if the U.S. capital - labor ratio is higher than Canada:
Kus / Lus > Kcan / Lcan
  Relative factor intensity: If bread (b) is the labor-intensive product and steel (s) is the
capital-intensive product, the capital-labor ratio required to produce bread must be less
than that required to produce steel: Kb / Lb < Ks /Ls
4. Provide an example that shows 1 country being capital abundant and the other country
being labor abundant. Also, provide an example that show one good being capital intensive
and the other being labor intensive. Finally, which country exports which good?
An example of country abundance: We can use the provided example (Table 4.1), suppose:
Country Capital Labor Capital-Labor Ratio

United States 50 machines 150 workers 1/3

Canada 2 machines 10 workers 1/5

Because the capital-labor ratio of The United States is 1/3 which is greater than the capital-labor
ratio of Canada, accounting for 1/5, so the United States is the relatively capital-abundant
country, and Canada is the relatively labor-abundant country.
An example of good intensity: Assume that production requires both capital and labor:
 Steel is the capital-intensive product.
 Bread is the labor-intensive product.
According to the HO theory, countries export goods that intensively use their relatively abundant
factors. Therefore:
• The United States that is capital abundant will export steel which is capital intensive.
• Canada that is labor abundant will export bread which is labor intensive.
5. The Stolper-Samuelson Theorem predicts that income accrues how? (Hint: you’ll need to
involve trade and factors of production).
The Stolper-Samuelson theorem predicts how changes in the prices of goods resulting from trade
affect the income earned by factors of production:
• Income accrual based on factor intensity and price changes: An increase in the price of a
good raises the income earned by factors that are used intensively in its production.
Conversely, a fall in the price of a good lowers the income of the factors that it uses
intensively.
• Income accrual based on abundance/ scarcity: Since trade causes the price of the export
good to rise and the price of the import good to fall, the theorem implies that the income
or returns earned by the abundant factor rises, while the income earned by the scarce
factor falls, regardless of the industry in which the factor is employed,.
• Magnified Effect: It states that the change in output prices has a larger effect in the same
direction on the income of the factor used intensively in its production
6. According to the Specific Factor Model, how do we determine which countries export
what good? Also, how does income accrue to the factors of production?
The specific factors model is a special case of the HO model where some factors are mobile (ex:
variable factor, usually labor), and some are immobile (ex: specific factors, like land or capital
dedicated to a single use).
As with the HO model, comparative advantage depends on factor endowments. A country
determines its exports by specializing in the good that intensively uses its relatively abundant
specific factor.
Income accrual to factors of production: The income effects differ for specific versus variable
factors when trade opens:
1. Specific Factor in the export sector: This factor experiences a rise in the demand for its
services, and therefore an increase in its income,. (e.g., Canadian landowners if Canada
exports bread).
2. Specific Factor in the import sector: This factor experiences a fall in the demand for its
services, and therefore its income declines.
3. Variable Factor (e.g., Labor): The income distribution effects on the mobile, variable
factor are indeterminate or ambiguous. This is because the mobile labor shifts to the
expanding sector, but the net effect on its real income depends on whether the rising price
of the exported good or the falling price of the imported good has a stronger overall
impact on their consumption patterns

7. Identify areas A, B, and C and also identify which type of country is on the left and right
panels.
Area A: It represents the labor-intensive good. At low levels of K/L, countries have relatively abundant
labor and scarce capital. These economies specialize in goods that use labor more intensively. Thus, Area
A corresponds to labor-abundant countries.
Area B: It represents the diversification range, where both the labor-intensive and capital-intensive goods
are produced simultaneously. In this range, the country has a balanced mix of labor and capital, so it has
not yet fully specialized in one type of good.
Area C: It represents the capital-intensive good. At high levels of K/L, countries have a large capital
endowment relative to labor. They specialize in goods that require heavy use of machinery and
technology, such as steel, automobiles, or electronics. Hence, Area C corresponds to capital-abundant
countries.
With left panel: The economy has a low K/L ratio, meaning it is labor-abundant. According to the H–O
model, this country will specialize in and export labor-intensive goods (Area A) while importing capital-
intensive goods (Area C).
With right panel: The economy has a high K/L ratio, meaning it is capital-abundant. This country will
specialize in and export capital-intensive goods (Area C) while importing labor-intensive goods (Area A).

8. Does trade have any effect on the number of jobs in the medium- and long-run and wage
inequality?
In the medium and long run, international trade has little or no effect on the total number of jobs
in a country, as the absolute number is primarily determined by population, labor market
policies, and the business cycle. However, trade does affect the composition of jobs, accelerating
the decline in manufacturing employment in sectors competing with imports.