Chapter 3 Summary

LO 3.1 Heckscher-Ohlin’s Theory of Trade and Its Implications

• The H-O theory asserts that comparative advantage comes from differences in resource endowments and in the intensity of resource use in production.
• A country should export products that intensively use its abundant resource and import those products that intensively use resources that are scarce domestically.
• The H-O theory indicates that gains and losses from trade depend on resource ownership. Owners of the resource used intensively in the expanding sector gain well-being from trade, while owners of the resource used heavily in the contracting sector lose.
• The H-O theory also suggests that free trade should cause the prices of individual resources to equalize across countries.
• International trade patterns are significantly consistent with the main prediction of the H-O theory – countries tend to export products that use their abundant resources intensively.

LO 3.2 Shortcomings of the Standard Trade Model as an Explanation for Intra-Industry Trade

• The standard theory of international trade suggests that countries should export one type of product and import a very different type of product – trade should be inter-industry. Indeed, much actual trade is inter-industry.
• However, standard trade theory does not adequately explain intra-industry trade – two-way trade in similar products – among countries whose resource endowments are similar.
• The limitations of the standard theory of trade stem from the assumptions on which it is based, in particular, that of perfect competition.
• To provide better explanations of intra-industry trade, we highlight models that incorporate imperfect competition and some of its features, such as product differentiation and economies of scale.

LO 3.3 Discuss Alternative Theories of International Trade

• We examined three alternative theories of trade – respectively, based on monopolistic competition and product differentiation, global oligopoly, and industries benefiting from external economies of scale.
• The monopolistic competition model suggests that intra-industry trade can be significant because consumers in each trading country demand unique foreign-made versions of the product.
• With intra-industry trade, there is little effect on the distribution of incomes – evident in the H-O model – because inter-sectoral shifts are limited. Exports offset domestic market share losses arising from imports of similar products.
• In a global oligopoly, the countries that happen to get production facilities become exporters while other countries become importers. The pattern of trade that results is arbitrary.
• The distribution of the gains from trade depends on whether the oligopolistic firms choose to collude or to compete. If they compete, potential economic surplus switches from producers to consumers and importing countries.
• In the case of an industry that benefits from external economies of scale, international trade lowers average costs and prices and increases consumer surplus in importing and exporting countries. This result differs from the standard theory whereby consumers in importing countries benefit while those in exporting countries lose.

LO 3.4 Effects of Technological Change on Production Location and International Trade

• Differences in the rates of technological progress among countries can cause changes in comparative advantage. The idea of shifting comparative advantage as a result of technological change is reflected in the product life cycle theory.
• According to the life cycle theory, there is a predictable cycle in which the home country exports a new product, then loses its comparative advantage to other countries as the technology becomes standardized, and eventually becomes an importer.
• The life cycle theory suggests that the location of production can change in line shifts in comparative advantage. Though it is dynamic in nature, the life cycle theory is largely consistent with its static H-O counterpart.

LO 3.5 Implications of Economic Growth for the Volume of Trade and the Terms of Trade

• Economic growth is an increase in a country’s production capabilities caused by increases in a country’s resource endowments, technological improvements, or some combination of these two factors.
• If economic growth is due to an expansion of a single sector due to a significant increase in a key resource or sector-specific technological change, such expansion can come at the expense of production in the other sector, as suggested by the Rybczynski Theorem.
• Economic growth can also increase a country’s willingness and ability to trade. Whether a country can trade more depends on the extent to which production and consumption change in response to growth.
• Economic growth can also alter a country’s terms of trade. If growth is concentrated in the import sector, an improvement in the terms of trade increases the country’s economic well-being. If growth is concentrated in the export sector and the country can affect the export price, increased exports can cause the terms of trade and national well-being to decline.

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