1.
International Economics
By Robert J. Carbaugh
8th Edition
Chapter 4:
Trade Model Extensions and
Applications

2.
Factor endowment theory (Heckscher-Ohlin)
Comparative advantage is explained entirely
by different national supply conditions,
especially resource endowments
Nations export products that use inputs which
are relatively abundant (cheap) at home, and
import products which need inputs which are
relatively scarce (expensive) at home
Why relative price differentials?

3.
Factor endowment theory: assumptions
Nations all have the same tastes and
preferences (same indifference curves)
They use factor inputs which are of uniform
quality
They all use the same technology
Why relative price differentials?

4.
Comparative advantage according to factor endowment theory
Factor endowment model
Autarky equilibrium

5.
Comparative advantage according to factor endowment theory
Factor endowment model
Post-trade equilibrium

6.
Factor endowment theory: implications
Factor price equalization
 The shift within each nation towards use of
cheaper factors, and away from expensive ones,
leads to more equal factor prices
Distribution of income
 Trade changes domestic distribution of income as
demand for different factors changes
Factor endowment model

7.
Economies of scale & specialization
Economies of scale provide incentives for
specialization, since per unit costs go down
as production increases
Trade provides a larger potential market for
products, making higher production levels
possible
Bringing theory closer to reality

8.
Economies of scale as basis for
trade
Economies of scale

9.
Trade & specialization under decreasing costs
Economies of scale

10.
Other extensions of the theory
Overlapping demands
 Factor endowment theory has considerable explanatory power for
trade in primary products and agricultural goods.
 The main force influencing manufactured-good trade is domestic
demand conditions.
 Firms’ incentive is large market  foreign buyers have similar taste
 firms begin to export. Taste = f(Y)  High income country will
demand high quality manufactured goods, nation with low per
capita incomes demand lower-quality goods Rich country will
likely trade with other rich countries, poor countries will trade with
other poor countries. overlapping demand
 Could not rule out all trade in manufactured goods between rich
and poor countries.
Bringing theory closer to reality

11.
Other extensions of the theory (cont.)
Intra-industry trade
 Involves two ways trade in a similar commodity
 Could be intensively found in advanced nations  with similar
resource endowments. Ex: Us exports IBM computers and imports
Hitachi computers from Japan
 Involves flows of goods with similar factor requirements. Firms that
produce these goods tend to be oligopolies
 Includes trade in homogenous as well as differentiated products
 Reason for intra-industry trade in homogenous goods:
 Transportation costs
 Seasonal factor & differentiation in time
 Reason for intra-industry trade in differentiated products:
 Taste. Domestic firms supply majority taste and nation imports to
fulfill minority taste
 Overlapping demand  similar taste
 Economies of scale  focusing on a few variety and style of a
product

12.
Other extensions of the theory (cont.)
Product cycles
 So far, the basis of trade was attributed to such factors as differing labor
productivities, factor endowments and national demand structures. Now,
technological change plays an important role in determining trade.
 Technological innovations result in:
 New methods of producing existing commodities
 Production of new commodities
 Commodity improvements
 Stages that many manufactured goods follow in terms of product cycle:
 Manufactured good is introduced to home market
 Domestic industry shows export strength
 Foreign production begins
 Domestic industry loses competitive advantage
 Import competition begins
 Trade cycle is complete when the production process becomes so
standardized that it can be easily used by other nations.

13.
Other extensions of the theory (cont.)
Dynamic comparative advantage - industrial policy
 Comparative advantage theory implies that nations are better off by
promoting free trade and allowing competitive markets to determine
what should be produced and how.  specialization and
reallocation of existing resource found domestically
 Criticism: Static theory
 Overlook the fact that additional resources can be made available to
the trading nation because they can be created or imported
 Increasing cost.  short run not in the long run (decreasing cost).
Possible partly because firms learn to be more efficient and partly
because of economies of large-scale production
 Dynamic comparative adv. Thorugh government policies (industrial
policy). Ex: Japan with picking winners policy
 Antitrust immunity, tax incentives, R&D subsidies. Loan guarantees,
low-interest-rate loans, and trade protection

14.
Free trade under increasing costs
Transportation costs
No transportation costs

15.
Free trade under increasing costs
Transportation costs
Transportation costs of $2000 per auto

16.
Specific factor theory
Looks at the income distribution effects of trade in the
short run, when some factor inputs are not mobile
among sectors
Indicates that workers may be better or worse off,
depending on preferences
Predicts that owners of factors used in export
industries gain from trade, while owners of factors
used in import-competing industries will lose from
trade
Bringing theory closer to reality

17.
Relative prices and the specific factor model
Bringing theory closer to reality