By: Dr. Jacqueline Khorassani
Week Three
1

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Tuesday, September 18
14:10-15:00
AC 202
I ordered 5 copies of the textbook for the library
I did not receive any questions from you on
Study Guide 3
– If you don’t ask, I assume you know
Expect an in class assignment tomorrow
2

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K/L in Brazil>K/L in China
3

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Production of computers is more capital intensive than production of shoes if
–Production of computers requires a higher K/L than production of shoes.
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Given a set of assumptions (outlined on page 62 of your book, ask me if you don’t understand the assumptions)
Brazil has comparative advantage over
China in production of computers if
1.
Production of computers is relatively capital intensive and
2.
Brazil is a relatively capital abundant nation 5

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K/L in US =1/2
K/L in Germany = 1/1
Which nation is labor abundant?
– US, because it has a higher L/K ratio
According to Factor-Proportions
Theorem, US has comparative advantage in production of goods and service that are ______ intensive.
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Pre-trade, which nation has a higher (Wage/price of capital) ratio?
– Germany
– Because labor is relatively more scarce in Germany
– Suppose (W/price of capital) ratio in
Germany = 5/5=1
– Suppose (W/price of capital) ratio in
US = 2/4 = 0.5
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US will specialize in production of
______ intensive goods and services.
Production of labor intensive goods in US will _______ while production of capital intensive in goods in
Germany will______.
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What does this do to demand for labor? For capital in US?
Wages? Price of capital?
–Demand for labor in the US will go
_____.
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–from 2 to 2.5.
–Demand for capital in the US will go __________.
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–from 4 to 3.5.
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The opposite happens in Germany
– Wage will go down from 5 to 4.2 and the price of capital will go up from 5 to 5.9
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Eventually, W/price of capital in both nations will be the same.
– 0.71
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This is referred to as factor-price equalization
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US Germany
Pre-trade:
W/price of capital
Post-trade:
W/price of capital
2/4= 0.5
5/5 =1
2.5/3.5 = 0.71 4.2/5.9 = 0.71
11

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Suppose Germany is labor scarce and capital abundant
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According to Factor
Proportions Theory,
Germany is likely to have comparative advantage in
________ intensive goods
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Germany will specialize in production of ______ intensive goods.
Capital
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Production of labor intensive goods in
Germany will go _______ while production of capital intensive in goods in
Germany will go ______.
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What does this do to demand for labor? For capital in Germany?
– Demand for labor will go down,
– Income of labor will go down.
– Demand for capital will go up,
– Income of the owners of the capital will go up
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This is the Stopler-Samuelson
Theorem
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Is US capital or labor abundant?
– Capital abundant
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According to Factor-Proportions
Theorem, US must be exporting
________ intensive goods and importing _________intensive goods.
Labor
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Leontief fund that US industries with trade surplus were more labor intensive than US industries with trade deficits  Paradox
15

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Some goods are land (natural resource) intensive (not the same of capital intensive)
Protectionism
Physical/human capital
Technology intensive goods
How about when we import and export the same goods?
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Specific factors of production can’t move between production of cars and bread
Examples?
Mobile factors of production can move between production of cars and bread
Examples?
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If the U.S. is well endowed with the specific factor used to produce cars, it will have comparative advantage in production of cars.
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Week Three- Class 2
– Wednesday, September 19
– 11:10-12:00 PM
– Tyndall
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Is it ok to use capital abundant in place of capital intensive?
– No, they mean different things
Would you penalize one for using rent as price of capital.
– No but I did not use the term rent because
– In economics price of capital is interest rate
– Rent is price of land (natural resources)
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Over the years,
– Per capita GDP has grown more sharply in South
Korea than in India
– The ratio of capital to worker has gone up more sharply in South Korea than in India
– Degree of openness (measured by (imports + exports)/GDP) has grown more sharply in South
Korea than in India.
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To not give you an In Class Assignment today
– Sorry, can’t do, because
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If you don’t keep up with class, after a while you will not benefit from the class
It is better to learn a little at the time.
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Most of this material builds upon the previous stuff
– At the end of semester, I will drop the bottom one or two assignment from the course grade.
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I will show you 3 multiple choice questions
On 1/2 sheet of a paper
Print your name
And put your answers down
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If Dutch labor can produce 3 soda pops in a day or 5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then __________ has a comparative advantage in yogurt cones.
– A) England
– B) both England and the Netherlands
– C) the Netherlands
– D) There is not enough information to answer this question.
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Which of the following is not a factor of production that the U.S. is abundant in?
– A) human capital
– B) unskilled labor
– C) skilled labor
– D) physical capital
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International trade tends to:
– A) have no effect on factor prices.
– B) cause the price of the scarce factor to rise and the price of the abundant factor to fall.
– C) cause all factor prices to fall.
– D) cause the price of the scarce factor to fall and the price of the abundant factor to rise.
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Intra-industry trade : Export and import within the same industry or product group.
– Example
Inter-industry trade: Some industries export and others import.
– Example
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Can factor proportions theory explain the Intraindustry trade?
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No
–Because that implies that a nation has comparative advantage as well as comparative disadvantage in production of the same product
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It is used to compare different industries based on their amount of intra-industry trading
Intraindustry Trade Index =1-
X -M
X+M
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X value of exports
M value of imports
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Intraindustry Trade Index =1-
X -M
X +M
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Example
–US imports $100,000 worth of autos and exports 30,000 worth of autos. What is ITI in the US auto industry?
–ITI = 1- (70,000/130,000) =
0.46
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Intraindustry Trade Index =1-
X -M
X+M
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What if ITI was zero?
– Country is either only exporting or only importing
– No intra-industry trade
How can ITI be 1?
– The country’s exports = its imports
– 100% intra-industry trade
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Values of intraindustry trade depend on how a particular industry or product group is defined.
– More broadly defined groups will show more intraindustry trade.
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Example: pants
– More narrowly defined groups will show less intraindustry trade.
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Example: dress pants and jeans
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Homogenous goods are those that are identical (consumers can not differentiate between them)
– Examples
Differentiated goods are those that are similar but not identical
– Examples
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Why is there intraindustry trade in homogeneous goods?
1. Location
 Transportation cost
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It is cheaper for City X to import cement from
County A than buy it from City Y
City Y will exports cement to Country C
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B imports and exports cement
Country
A
City X Country B
City
Y County
C
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Week Three- Day 3
– Wednesday, September 19
– 15:10-16:00
– AC 201
Let’s review this morning’s ICA
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If Dutch labor can produce 3 soda pops in a day or
5 yogurt cones in a day, while British labor can produce 2 soda pops and 4 yogurt cones, then
__________ has a comparative advantage in yogurt cones.
– A) England
– B) both England and the Netherlands
– C) the Netherlands
– D) There is not enough information to answer this question.
Answer: A
– Opportunity cost of 1 yogurt in England =2/4= 0.5 sodas
– Opportunity cost of 1 yogurt in Netherlands = 3/5 = 0.6 sodas
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Which of the following is not a factor of production that the U.S. is abundant in?
– A) human capital
– B) unskilled labor
– C) skilled labor
– D) physical capital
Answer: B
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International trade tends to:
– A) have no effect on factor prices.
– B) cause the price of the scarce factor to rise and the price of the abundant factor to fall.
– C) cause all factor prices to fall.
– D) cause the price of the scarce factor to fall and the price of the abundant factor to rise.
Answer: D
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Why is there intraindustry trade in homogeneous goods?
2. Joint products
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Country A imports goods + insurance (service)
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Country A exports other goods + insurance (service)
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Why is there intraindustry trade in homogeneous goods?
3. Entrepot trade
– A computer producer in country X has a worldwide distribution center in country
Y
Y imports
Country
X
Country
Y and exports the same computers
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Why is there intraindustry trade in homogeneous goods?
4.
Re-export trade.
– Goods are imported into a country, and sometime later the same goods are subjected to a small transformation and exported to another country.
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Example: Goods are imported, sorted, repackaged and exported to another country to the Far East.
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Explanations of Intraindustry Trade in Homogeneous Products
5.
 Country A may only produce strawberries in summer
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Export strawberries in summer
Import strawberries in winter
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1.
Horizontally differentiated products have the same price but slightly different characteristics
– Examples?
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Candy bars
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2. Vertically differentiated products have different prices and different characteristics
–Examples?
 autos
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Why would a nation export and import differentiated goods?
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Price differentials (vertically differentiated products)
– Economies of scale
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What is it?
Average cost goes down as you increase production
– Specialization
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Example
Compact cars are popular in Japan
Japan increases its production of compact cars
Average cost of producing compact cars declines in Japan
Japan gains a comparative advantage in production of compact cars
Japan exports compact cars
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Why would a nation export and import differentiated goods?
Big cars are popular in the US
US increases its production of big cars
Average cost of producing big cars declines in US
US gains a comparative advantage in production of big cars
US exports big cars
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Explains why we may turn from exporting a product to importing that product over time.
From the time a new high tech product is developed to the time in becomes widely popular, it goes through 3 stages
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Stage 1
– Computers are just introduced to the market in the US
– They are expensive
– Need high-income markets
– R&D and production improvements require highly skilled workers.
– US may export computers to other developed countries
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Production of computers becomes more standardized.
Production may move to other developed countries instead of exporting to those countries.
US may begin to import computers from the new production country.
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Production of computers has become standardized enough that move process to developing countries to utilize unskilled labor to lower costs.
US becomes importer.
US moves production focus to new products and cycle starts over.
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Domestic producers produce goods targeted at tastes and income levels of the domestic market.
Goods are exported to other countries with similar tastes and income levels .
Linder states that high-income countries will trade with other high-income countries since income determines general tastes/preferences.
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Welfare is improved from increased choice and competition.
– Prices tend to be lower with trade in differentiated products.
– Quality tends to be higher.
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Reduces monopoly power of domestic firms
Firms can produce at higher levels realizing economies of scale leading to lower prices.
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