CFA Level I · CFA Level I Exam · International Trade
Two countries have similar factor endowments, yet each exports and imports differentiated cars to and from the other. The explanation most consistent with this pattern is:
Economies of scale and consumer demand for product variety best explain it. When endowments are similar, comparative advantage models predict little trade, but firms specializing in differentiated products at larger scale create two-way intra-industry trade, as in new trade theory.
- Adifferences in relative labor productivity between the two countries
- Beconomies of scale and consumer demand for product varietyCorrect
- Cgains from the Heckscher-Ohlin factor price equalization process
Explanation
Intra-industry trade between similar economies is explained by the new trade theory: economies of scale and preference for variety, with firms specializing in differentiated products. Ricardian productivity differences and Heckscher-Ohlin endowment differences would predict inter-industry trade, not two-way trade in similar goods.
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