Question

6. Violations of the factor-endowment theory of trade

While different natural resources and the theory of comparative advantage can explain many trade patterns, they cannot explain all types of trade that economists observe.

Consider each scenario in the following table and determine which theory best explains the trade pattern described.

Scenario	Dynamic Comparative Advantage	Product Life Cycle Theory	Intra-Industry Specialization
Ice wine is a special spirit that can only be made during a few months in the winter. The nations of Fruzenton and Grappovia are in different hemispheres, and each produces ice wine. During each nation’s winter, its ice wine industry produces enough to meet domestic demand and export to the other country. The ice wine exchanged between the two nations is nearly identical.
For many years, the nation of Stilettopia’s high-heel shoe producers have struggled in the international market because strict labor laws have made it hard to get productivity out of Stilettopians. In an effort to stimulate its industry, legislators in Stilettopia approve a bill that reduces the minimum wage and extends the number of hours shoe laborers can work in a day. Once the new policies take effect, Stilettopian high-heel shoe makers have lower costs than international competition and are able to reduce prices to the point that there is demand to export their shoes.
Since the turn of the century, nearly all X-ray machines purchased by hospitals have been made in Alloway. However, engineers in Osteoville recently designed an X-Ray machine that produces much more accurate results, leading to fewer malpractice cases and more reliable diagnoses. These new X-ray machines quickly become the industry standard. As a result of this, the production of X-ray machines is thriving in Osteoville, while firms in Alloway lose market share and begin trying to develop a new source of advantage.

Answer 1

1. The first trade pattern is one of intra industry specialisation. Intra industry specialisation is a situation where different firms specialize in particular products within the same industry. Here the industry is ice wine industry. Rather than competition between two nations producing the same product, we find that two nations have specialised in the production and have domestic and foreign demand without impacting the sales of the other nation. This peculiar situation can be attributed to the nature of product produced and location of the two nations. Ice wine can be produced only in winter and the two nations are located in two hemispheres. Thus we see the market for ice wine being shared between the two nations over a year. The nation located in the northern hemisphere produces and sells ice wine when Northern Hemisphere experiences winter and the nation located in the southern hemisphere produces and sells ice wine when SH experiences winter.

Thus the two nations have specialized and sell in the domestic and foreign market the same product owing to nature of the product and location of the producers.

2. The second situation is one of Dynamic Comparative Advantage. Compartive advantage is rarely a static phenomenon. The factors in which a country enjoys compartive advantage (CA) changes over time. If the CA was in labour once, it could be in technology today. In the second trade situation, a change in government policy enabled the firm to enjoy CA in labour which it did not enjoy earlier due to strict labour laws. This the dynamic nature of CA allowed the firm to reduce posts and complete internationally.

3. Product Life cycle (PLC) theory

According to PLC , every product has a life cycle. It undergoes through various phases in response to market conditions. The various stages being - introduction, growth, maturity and decline. The Alloway X-rays underwent this product life cycle. Intially it enjoyed a monopoly in X-rays. But as news entities entered the X-ray market such as Osteoville, Alloway lost market power and entered the stage of decline. While being the only seller was the advantage enjoyed by Alloway earlier, it now has to look for different advantage to compete with advanced X-rays that have entered the market (to initiate product life cycle for the improved Alloway X-ray again )