Week 4

Suggested Solution

Chapter 4

1. According to the following table, which country is relatively more labor-abundant? Explain your
answer. Which country is relatively more capital-abundant?

Japan Indonesia
Capital 10 machines 30 machines
Labor 20 workers 50 workers

Answer: The capital-labor ratios are 1/2 and 3/5 for Japan and Indonesia. Since 3/5 is more than
1/2, Indonesia is capital abundant. By the same reasoning, the labor-capital ratio is 2 in
Japan and 5/3 in Indonesia. Thus, Japan is labor abundant.

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2. Suppose that Japan and Indonesia have the factor endowments in the preceding table. Suppose
further that the production requirements for a laptop computer are 5 machines and 10 workers, and

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the requirements for a unit of cloth are 2 machines and 5 workers.
a. Which good, computer or cloth, is relatively capital-intensive? Labor-intensive? Explain your

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answer.
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b. Which country would export cloth? Why?
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Answers:
a. The capital-labor ratio to make a laptop computer is 1/2 and to make a unit of cloth is 2/5.
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Hence, computers are more capital intensive and cloth is more labor intensive.
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b. Since Japan is labor abundant and Indonesia is capital abundant, according to the Heckscher-
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Ohlin trade model, Japan will export cloth and Indonesia will export computers.

[The answer seems counter-intuitive in the real world, but the answer itself is correct. If we
switch ‘Japan’ and ‘Indonesia’ in the table of the question, that it makes more sense in the real
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world, where Japan is actually Capital abundant and Indonesia is actually labor abundant.]
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5. Suppose that there are three factors: capital, labor, and land. Bread requires inputs of land and labor,
and steel requires capital and labor.
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a. Which factors are variable, and which are specific?

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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?
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Answers:
a. Labor is the variable factor and capital and land are specific.
b. Canada is land abundant relative to the United States (100/10 is greater than 100/50), so
Canada’s comparative advantage is in the export of bread, the good with the specific input of
land. The United States’ comparative advantage is steel.
c. In the United States, owners of land are hurt by trade, owners of capital benefit, and the effects
on labor are indeterminate. The latter effect depends on labor’s preference for bread and steel. In

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 the United States, bread prices fall, but steel prices rise. In Canada, owners of land benefit from
trade, owners of capital are hurt, and the effects on labor are indeterminate. The latter effect
depends on labor’s preference for bread and steel. In Canada, bread prices rise, but steel prices
fall.

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
the final market can have cost advantages. The European market may have design
preferences that are different from the U.S. market (i.e., driving on the right side of the
road, fuel economy given higher gas prices, higher speed limits, and the need for power on
highways… ). This would give advantages to a production location with more direct
access to the final market. Other auto manufacturers that could handle production are
GM’s direct competition, making GM unlikely to choose licensing and a sharing of its
manufacturing, design, and technology.

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