In assuming labor is the only factor of production, Ricardo characterized labor productivity as the sole basis of comparative advantage and thus of trade. By allowing for multiple factors of production, by contrast, the Hecksher–Ohlin theory can account for the determinants of comparative advantage, namely, relative factor endowments. Additionally, the multiple-factor framework of the Heckscher–Ohlin theory can be used to account for the distributional effects of trade. The Stolper–Samuelson theorem, an extension of the Heckscher–Ohlin theory, states that an increase in the price of a product increases the income earned by factors used intensively in its production, while a decrease in the price of a product reduces the income of factors used intensively in its production. See section: “The Factor-Endowment Theory.”
4. Study Questions #4. Ch 3.
Evaluate the following statement.
True or False: The Stolper–Samuelson theorem states that the abundant resource that fosters comparative advantage realizes a decrease in income and the scarce resource realizes an increase in its income regardless of industry.
The Stolper–Samuelson theorem states that the export of products embodying large amounts of relatively cheap, abundant factors makes those factors less abundant domestically, leading to higher prices and thus an increased share of national income for these factors. The magnification effect is an extension of the Stolper-Samuelson theorem that suggests that the change in the price of a resource is greater than the change in the price of the good that uses the resource relatively intensively in its production process.
Suppose that as the U.S. starts trading, the price of aircraft (capital intensive good) increases by 6% and the price of textiles (labor intensive good) decreases by 3%.
According to the magnification effect
, the price of capital must rise
than 6%, and the price of labor must fall
than 3%. If the price of capital increases by more than 6%,owners of capital
are better off whereasworkers
are worse off.
In this case, the magnification effect implies that the price of capital must rise by more than 6%, while the price of labor must fall by more than 3%. If the price of capital increases by 6%, owners of capital are better off whereas workers are worse off. See section: “Who Gains and Loses From Trade? The Stolper–Samuelson Theorem.”
5. Study Questions #5. Ch 3.
An empirical test of the factor-endowment theory, undertaken by Wassily Leontief in 1954, revealed that the U.S. capital/labor ratio for export industries was lower than that of its import-competing industries.
Evaluate the following statement to indicate whether it accurately explains how the Leontief paradox challenges the overall applicability of the factor-endowment model.
True or False: The Leontief tests, as well as a number of empirical tests that followed, suggest that the determinants of trade are more complex than those predicted in the basic factor-endowment theory. This is because a large amount of international trade is not between industrialized and developing countries but is among industrialized countries with similar resource endowments. Thus, such factors as technology, demand conditions, and a time dimension to comparative advantage must also be considered.
In 1954, Wassily Leontief found that the capital/labor ratio for U.S. export industries was lower than that of U.S. import-competing industries. He thus concluded that U.S. exports were less capital intensive than its import-competing goods, a conclusion known as the Leontief paradox because it contradicted the predictions of the factor-endowment theory. Leontief’s empirical findings brought into question the applicability of the factor-endowment theory by suggesting that the United States predominantly exported labor-intensive goods. This conclusion contradicted the prediction of the factor-endowment theory when applied to the United States. To strengthen his conclusion, Leontief repeated his tests only to again find that U.S. import-competing goods were more capital intensive than U.S. exports. Leontief’s discovery was that America’s comparative advantage lay in something other than capital-intensive goods. The empirical tests highlighted the importance of the fact that a large amount of international trade is not between industrialized and developing countries but is among industrialized countries with similar resource endowments. Thus, the determinants of trade are more complex than those identified by the basic factor-endowment theory, as factors such as technology, economies of scale, and demand conditions must also be included in the model. See section: “Is the Factor-Endowment Theory a Good Predictor of Trade Patterns? The Leontief Paradox.”
6. Study Questions #6. Ch 3.
Evaluate the following statement to indicate whether it accurately explains Staffan Linder’s theory of overlapping demands.
True or False: According to Linder’s theory of overlapping demands, the foreign markets with the greatest export potential are found in nations with consumer demands similar to those of domestic consumers.
Staffan Linder, a Swedish economist in the 1960s, maintained that the factor-endowment theory is valid for trade in primary products, but the theory of overlapping demands best applies to trade in manufactured goods. Linder states that a nation’s exports are thus an extension of the production for the domestic market. See section: “Overlapping Demands as a Basis for Trade.”
7. Study Questions #7. Ch 3.
The product life cycle theory views a variety ofmanufactured
goods as going through a trade cycle, during which a nation initially is anexporter
, then loses its markets, and finally becomes animporter
of the product.
The product life cycle theory views a variety of manufactured goods as going through a trade cycle, during which a nation initially is an exporter, then loses its export markets, and finally becomes an importer of the product.
Which of the following is an accurate statement regarding empirical studies of trade cycles?
Empirical studies have demonstrated that trade cycles do exist for manufactured goods at some times. See section: “Technology as a Source of Comparative Advantage: The Product Cycle Theory.”
8. Study Questions #8. Ch 3.
True or False: Economies of scale exist when expansion of the scale of production causes total production costs to increase more than proportionately to output, which causes long-run average costs of production to increase.
Economies of scale (increasing returns to scale) exist when an expansion of the scale of productive capacity of a firm or industry causes total production costs to increase less than proportionately to output. Thus, long-run average costs of production decrease. See section: “Economies of Scale and Comparative Advantage.”
Which of the following are correct descriptions of the effects of economies of scale on world trade patterns? Check all that apply.
Economies of scale are classified as internal economies and external economies. Internal economies of scale arise within a firm itself and are built into the shape of its long-run average cost curve. External economies of scale exist when the firm’s average costs decrease as the industry’s output increases. A key aspect of economies of scale is the home market effect, the tendency of countries to specialize in products for which there is significant domestic demand. In particular, by locating near its largest market, an industry can minimize shipping costs even as it takes advantage of economies of scale. See section: “Economies of Scale and Comparative Advantage.”
9. Study Questions #9. Ch 3.
Which of the following accurately defines intra-industry trade?
Inter-industry trade refers to the exchange between nations of products of different industries. Intra-industry trade, on the other hand, refers to two-way trade in a similar product. Determinants of intra-industry trade include the following: (1) overlapping demand segments in trading countries, (2) the extent to which domestic producers ignore “minority” consumer tastes, and (3) economies of scale associated with differentiated goods. See section: “Intra-industry Trade.”
10. Study Questions #10. Ch 3.
Which of the following are problems encountered when attempting to implement industrial policy? Check all that apply.
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 comparative advantage requires the government to identify industries with the highest growth prospects. Problems of industrial policy include the following: (1) difficulties in identifying growth-oriented industries and (2) the potential for government policy makers to be unduly influenced by their voting constituents. See section: “Dynamic Comparative Advantage: Industrial Policy.”
11. Study Questions #11. Ch 3.
Evaluate the following statement about the effect of government regulatory policies on an industry’s international competitiveness.
True or False: Government regulatory policies weaken antitrust laws and increase the future competitiveness of affected industries.
Government regulations imposed on domestic producers lead to higher production costs and a decrease in competitiveness. Thus, although such regulations may improve the well-being of the public, they negatively affect trade performance. Nations that impose more stringent and costly government regulations on their producers, relative to other countries, tend to lessen their international competitiveness. For example, environmental regulation adds to the costs of domestic steel companies making the United States more dependent on foreign-produced steel. However, regulations provide American households with cleaner water and air, and thus a higher quality of life. The competitiveness of other American industries, such as forestry products, may benefit from cleaner air and water. These effects must be considered when forming an optimal environmental regulatory policy. See section: “Government Regulatory Policies and Comparative Advantage.”
12. Study Questions #12. Ch 3.
Evaluate the following statement explaining the factors determining international trade in services.
True or False: The principle of absolute advantage applies to international trade in services.
As with trade in manufactured goods, the principle of comparative advantage also applies to trade in services. International trade in business services is governed by factors such as these: (1) employee skills and compensation levels, (2) a firm’s ability to organize its employees in a productive manner, (3) availability of capital equipment, and (4) potential for economies of scale made possible by a market’s size. See section: “Factor-Price Equalization.”