Lecture Slides Chapter 03.pptVIP

Sources of Comparative Advantage Chapter 3 Copyright ? 2009 South-Western, a division of Cengage Learning. All rights reserved. Factor Endowment Theory economists Heckscher and Ohlin explanation of: determinants of comparative advantage impact of trade on earnings of factors nation will export goods which it produces with resources that are relatively abundant nation will import goods which it produces with resources that are relatively scarce Factor Endowment - Example U.S.: capital/labor ratio = 0.5 (100/200) China: capital/labor ratio = 0.02 (20/1,000) Since the U.S. has relatively more abundant capital, the U.S. will produce capital-intensive goods with China producing goods that are more labor-intensive. Graphical Example U.S. MRT = 0.33 China’s MRT = 4.0 implication is that U.S. has a lower relative price in aircraft so U.S. has comparative advantage in aircraft China has comparative advantage in textiles Graphical Example (cont.) equilibrium at points B and B ? where slopes of PPCs are equal represents equal relative price for each country U.S. trades 6 aircraft to China for 6 textiles resulting in point C for consumption Implications of Factor Endowment U.S. - relatively abundant capital China - relatively abundant labor expectation – U.S. produces capital intensive goods and China produces labor intensive list of top exports confirm theory’s suggestions Factor Price Equalization specialization causes U.S. to use more capital and China to use more labor increases price of capital in U.S. and the price of labor in China until factor costs are equal Stolper-Samuelson Theory increased income for producers of goods associated with relatively abundant resources decreased income for producers of goods associated with relatively scarce resources magnification effect – change in price of the resource is greater than the change in the price of the good produced with that resource implication: overall, free trade provides gains to a nati