MACASADIA, KIER M.

BSBA-3B

1. Specific Factor and Income Distribution  

I. INTRODUCTION

Trade has substantial effects on the income distribution within each trading nation. There are two
main reasons why international trade has strong effects on the distribution of income. First, resources
cannot move immediately or costless from one industry to another. Second, industries differ in the
factors of production they demand. The specific factor model allows trade to affect income
distribution.

II. BODY

The specific factors model was developed by Paul Samuelson and Ronald Jones. Like the simple
Ricardian model, it assumes an economy that produces two goods and that can allocate its labor
supply between the two sectors. Unlike the Ricardian model, however, the specific factors model
allows for the existence of factors of production besides labor. Whereas labor is a mobile factor that
can move between sectors, these other factors are assumed to be specific. That is, they can be used
only in the production of particular goods.

In the model, we assume that there are two factors of production, land and capital are
permanently tied to particular sectors of the economy. In advanced economies, however, agricultural
land receives only a small part of national income. When economists apply the specific factors model
to economies like those of the United States or France, they typically think of factor specificity not as
a permanent condition but as a matter of time. For example, the vats used to brew beer and the
stamping presses used to build auto bodies cannot be substituted for each other, and so these different
kinds of equipment are industry-specific. Given time, however, it would be possible to redirect
investment from auto factories to breweries or vice versa. As a result, in a long-term sense both vats
and stamping presses can be considered to be two manifestations of a single, mobile factor called
capital.

III. LEARNING INSIGHTS

International trade often has strong effects on the distribution of income within countries, so
that it often produces losers as well as winners. Income distribution affects arise for two reasons.
First, factors of production cannot move instantaneously and costless from one industry to
another. Second, changes in an economy’s output mix have differential effect on the demand for
different factors of production.

IV. CONCLUSION

A useful model of income distribution effects of International trade is the Specific Factor
Model. In this model, differences in resources can cause countries to have different relative
supply curves, and thus cause International trade. In the Specific Factor Model, factors specific to
export sectors in each country gain from trade, while factors specific to import-competing sectors
lose. Mobile factors that can work in either sector may either gain or lose. Trade nonetheless
produces overall gains in the sense that those who gain could in principle compensate those who
lose while still remaining better off than before.
2. External Economies of Scale and International Trade 

I. INTRODUCTION

One important motivation for international trade is the efficiency improvements that can
arise because of the presence of economies of scale in production. Although economists wrote
about these effects long ago, models of trade developed after the 1980s introduced economies of
scale in creative new ways and became known as the “New Trade Theory.” Another major reason
that international trade may take place is the existence of economies of scale (also called
increasing returns to scale) in production.

II. BODY

Economies of scale means that production at a larger scale (more output) can be achieved at a
lower cost (i.e., with economies or savings). When production within an industry has this
characteristic, specialization and trade can result in improvements in world productive efficiency and
welfare benefits that accrue to all trading countries.

Trade between countries need not depend on country differences under the assumption of
economies of scale. Indeed, it is conceivable that countries could be identical in all respects and yet
find it advantageous to trade. For this reason, economies-of-scale models are often used to explain
trade among countries like the United States, Japan, and the European Union. For the most part, these
countries, and other developed countries, have similar technologies, similar endowments, and to some
extent similar preferences. Using classical models of trade (e.g., Ricardian, Heckscher-Ohlin), these
countries would have little reason to engage in trade. Yet trade between the developed countries
makes up a significant share of world trade. Economies of scale can provide an answer for this type
of trade.

Another feature of international trade that remains unexplained with classical models is the
phenomenon of intra industry trade. A quick look at the aggregate trade data reveals that many
countries export and import similar products. For example, the United States imports and exports
automobiles, imports and exports machine tools, imports and exports steel, and so on. To some
extent, intra industry trade arises because many different types of products are aggregated into one
category. For example, many different types of steel are produced, from flat-rolled to specialty steels.
It may be that production of some types of steel requires certain resources or technologies in which
one country has a comparative advantage. Another country may have the comparative advantage in
another type of steel. However, since all these types are generally aggregated into one export or
import category, it could appear as if the countries are exporting and importing “identical” products
when in actuality they are exporting one type of steel and importing another type.

III. LEARNING INSIGHTS

The presence of economies of scale in production represents another reason countries may trade
with each other. Economies-of-scale models are used to explain intra industry trade—that is,
trade between countries with similar characteristics, like the United States and Canada.
IV. CONCLUSION

Nevertheless, it is possible to explain intra industry trade in a model that includes economies
of scale and differentiated products even when there are no differences in resources or
technologies across countries. This model is called the monopolistic competition model. Its focus
is on consumer demand for a variety of characteristics embodied in the goods sold in a product
category. In this model, advantageous trade in differentiated products can occur even when
countries are very similar in their productive capacities.