Explain the factor proportions theory and discuss why it is at odds with the new trade theory

Question

What will be an ideal response?

Answer 1

In the early 1900s, an international trade theory emerged that focused attention on the proportion (supply) of resources in a nation. The cost of any resource is simply the result of supply and demand: Factors in great supply relative to demand will be less costly than factors in short supply relative to demand. Factor proportions theory states that countries produce and export goods that require resources (factors) that are abundant and import goods that require resources in short supply. Factor proportions theory says that a country specializes in producing and exporting goods using the factors of production that are most abundant and thus cheapest-not the goods in which it is most productive.
In contrast, the new trade theory states that 1. there are gains to be made from specialization and increasing economies of scale, 2. the companies first to market can create barriers to entry, and 3. government may play a role in assisting its home companies. Because the theory emphasizes productivity rather than a nation's resources, it is in line with the theory of comparative advantage but at odds with factor proportions theory.