Chapter 3: Problem 4

The factor-endowment theory demonstrates how trade affects the distribution of income within trading partners. Explain.

Short Answer

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The factor-endowment theory posits that countries export goods that use locally abundant factors and import goods that require locally scarce factors. This affects income distribution as exports increase the demand and price of the abundant factor, and therefore the income to its owners, while imports decrease the demand and price of scarce factors, reducing the income of its owners.

Step by step solution

Definition of Factor-Endowment Theory

The factor-endowment theory, also known as Heckscher-Ohlin theory, is an economic theory that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce.

Effect on Income Distribution

According the factor-endowment theory, trade affects the distribution of income in the way that it influences the prices of the factors of production. When a country exports a good that is intensive in its abundant factor, the demand for that factor increases, which drives up its price and thus, the income to its owners. On the other hand, when a country imports a good that is intensive in its scarce factor, the demand for that factor decreases domestically, which drives down its price and, hence, reduces the income to its owners.

Application in Trade Context

In a trade context, the factor-endowment theory could explain how trade can lead to income redistribution within countries. For instance, assuming labor is abundant in country A and capital is scarce, increasing trade in a labor-intensive good would benefit the workers in country A, making them relatively richer, whereas the owners of capital might become relatively poorer.

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The factor-endowment theory demonstrates how trade affects the distribution of income within trading partners. Explain.

Short Answer

Step by step solution

Definition of Factor-Endowment Theory

Effect on Income Distribution

Application in Trade Context

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