2/19 BUS 313
Conditions of Comparative Advantage
Comparative advantage explains why countries choose to trade.
Key condition: when a product intensively uses a relatively abundant factor of production.
Relatively abundant factor: a factor that is abundant compared to other production factors (land, labor, capital).
Factors of Production
Three primary factors: land, labor, and capital (machinery).
A country will likely trade if a product intensely uses a relatively abundant factor, enhancing its comparative advantage.
Land and Oil Resources
Example of land as a factor of production: oil-rich regions.
Oil is considered a scarce resource, with nations like Venezuela and Iraq heavily dependent on it.
Countries endowed with oil face a resource curse, as over-reliance on oil can lead to instability.
High dependence on one resource (like oil) can be detrimental if the resource becomes scarce or unpopular.
Labor and Capital in Oil-Dependent Countries
Oil reserves attract labor and capital investments; thus, the workforce gravitates towards oil production.
Example: Venezuela's economy, where 97% of exports are petroleum-related.
Labor is drawn into oil production activities—drilling, managing land, etc.
Resource Curse
Countries blessed with oil face challenges due to dependence on a volatile resource.
Possible outcomes include running out of oil or policy changes that affect the oil market.
Example: Canada has diversified its economy, not relying entirely on oil (oil accounts for only 22.3% of exports).
Canada also manufactures cars and aircraft, showcasing a diverse production base.
Economic Challenges from Resource Abundance
Resource abundance can lead to political turmoil and corruption, known as the resource curse.
Even strong governments can experience corruption due to wealth from resources.
Example: United States' reliance on the high-tech industry leading to political dependencies.
Empirical Testing of Comparative Advantage Theory
The Ricardian and HO models help understand trade motivations.
The HO model incorporates multiple factors of production—more complex to prove empirically.
Labor productivity influences which goods a country will likely export.
Economic Policies and Trade Barriers
Trade policies such as tariffs and quotas can influence trade dynamics.
Economies of scale may affect comparative advantage and trade strategies.
The Gravity Model
The gravity model explains trade relationships based on size and distance between economies.
Closer, larger economies tend to trade more extensively (e.g., US-Mexico).
Size is evaluated using GDP (gross domestic product).
The Product Cycle Model
High-income countries, like the US, innovate and produce products early in the product cycle.
Early adapters generate revenue and feedback that fosters product growth.
As products mature, manufacturing shifts to lower-income countries to cut costs, exemplifying the outsourcing trend.
Comparative Advantage in Practice
China exemplifies the intensive use of labor as a comparative advantage.
Labor-driven economy producing inexpensive goods such as toys, furniture, apparel, etc.
Rising technological capabilities in manufacturing, including telecommunications equipment.
Differences in Economic Structure
Comparison between manufacturing in China and services in the US:
China focuses on low-cost manufacturing; the US has transitioned predominantly to a service-based economy.
Labor in the US tends to be more skilled and higher paid than in developing countries.
Foreign Trade and Investment
Foreign trade involves exports and imports of goods, while intra-firm trade occurs within an international company's subsidiaries.
Key benefits of establishing subsidiaries include:
Protection of technology, lower production costs, and reduced complexity in contracts.
The OLI (Ownership