Chapter 4: Comparative Advantage and Factor Endowments

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

1. Definitions
Magnification Effect: the change in output prices has a magnified effect on factor incomes.

Intrafirm trade: international trade between a parent company and a foreign owned affiliate.

Off-shoring: is defined as the movement of some or all of a firm’s activities to a location

outside the home country

Outsourcing: is the reassignment of activities to another firm, either inside or outside the
home country

2. 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 that income accrues based on the impact of
international trade on factor prices (wages for labor and returns for capital). Specifically:
1. 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 used intensively in its production.
2. As a country opens up to trade, its production shifts towards goods that utilize its most
abundant factor of production intensively. This leads to an increase in the returns to that
abundant factor and a decrease in the returns to the scarce factor.
3. As a country moves towards its factor-intensive and abundant good, wages (profits, rents)
increase for that factor. This means that the factors used in the exported good see an
increase in their income, while the factors used in the imported good (declining sector)
see a decrease in their income.
In essence, if a country is capital abundant and the good it exports is capital intensive, the owners
of capital in that country will see an increase in their income due to trade. Conversely, if the
imported good is labor-intensive in a capital-abundant country, the labor in that country will
experience a decrease in real wages.

4. According to the Specific Factor Model, how do we determine which countries

export what good?
 A country’s endowment of a specific factor plays a more critical role in determining
comparative advantage. For instance, the US is relatively well endowed with capital, and
China is relatively well endowed with unskilled labor. Thus, China exports phones, and
the United States exports circuits.
Also, how does income accrue to the factors of production?

 When trade opens, incomes rise for the owners of the abundant specific factor and fall for
the less abundant specific factor.
 The income distribution effect on the variable factor is indeterminate, as workers (or the
variable factor) can easily move to the expanding sector. This is because the variable
factor is mobile and can migrate from one sector to another.
 The change in income distribution depends on the net effect. For instance, if falling
circuit prices (due to China importing US circuits) outweigh rising phone prices (because
phones are priced higher in trade than in autarky), then Chinese workers benefit in terms
of consumption and income. The same analysis applies for the U.S., but with the roles of
phones and circuits reversed.
4. Identify areas A, B, and C and also identify which type of country is on the left and right
panels.

Left Panel:
 Area A: Defines the point in time and quantity at which production is less than
consumption. This could be the stage of product introduction when demand outpaces
supply locally, resulting in imports.
 Area B: Production starts to catch up with consumption during this transitional period
and finally surpasses it. The nation may begin to produce the good more effectively and
depend less on imports.
 Area C: Represents the quantity and duration at which production exceeds consumption.
There may be a stage at which domestic production becomes so efficient that it outpaces
domestic demand, opening up the possibility of exporting.
Based on the curves' shape and transition, the left panel most likely depicts a developing or low-
income nation. They consume more than they generate at first, maybe as a result of a lack of
knowledge or resources. But eventually, as they acquire the resources to create effectively, they
begin to export.
Right Panel:
 Area A: Denotes a time when production stays largely unchanged but demand rises
steadily. This could be the stage where the product is novel and inventive, and the nation
may be a leader in its use.
 Area B: In this instance, output begins but remains below consumption, suggesting that
the nation may still need to import in order to meet its needs.
 Area C: Both production and consumption are rising throughout this phase, but
production appears to be increasing more quickly than demand, suggesting a possible
surplus in the future.
Based on the development shown in the right panel, this most likely depicts a developed or
wealthy nation. They start off by using cutting-edge products, and once they catch on, they start
making them. Their capacity for production may eventually cause them to export the goods.5.
Does trade have any effect on the number of jobs in the medium- and long-run and wage
inequality?
Trade has very little effect on the number of jobs over the medium and long terms. But it's more
likely that advances in capital and technology will result in lower labor costs. With more
technology, unskilled labor is less likely to be utilized, increasing pay disparity.