Supplementary notes

Chapter 4

Heckscher-Ohlin Model

• Resource endowment as the key to comparative advantage

• Two factors of production: Labor and Land

• The PPF is no longer a straight line. The opportunity cost in production increases as more of a product is produced. Why?– More than one factor of production– Possibility of substitution between the factors

Factor Intensity and Factor Abundance

Assumption. Cloth is labor intensive and Food is land intensive.

Assumption. Home is labor abundant, Foreign is land abundant: L/T > L*/ T*

Assumption. The resource endowment is the only difference in the two countries. They share the same technology, same preferences, etc.

In the textbook, – the two factors are LABOR and LAND. – the two goods are CLOTH and FOOD.– the two countries are HOME and FOREIGN.

Factor Prices, Input Choices

Factor Prices and Goods Prices

Factor Prices, Goods Prices

and Input Choices

Relative Pricesbefore and after trade

Equilibrium

• Production equilibrium– Occurs where the relative price and the slope

of the PPF (the opportunity cost) are equal

• Consumption equilibrium– Occurs where the relative price and the slope

of an indifference curve (consumers’ relative evaluation) are equal

Equilibrium in autarky

• Occurs where the PPF and an indifference curve are tangent to each other and thus have the same slope.

• The equilibrium relative price is determined by the tangent line.

Autarky

The Heckscher-Ohlin Theorem

A country has comparative advantage in the product which makes intensive use of productive factors with which it is abundantly endowed with.

• Home labor abundant CA in cloth which is labor intensive

• Foreign land abundant CA in food which is land intensive

Trade Equilibrium

Home Foreign Initial conditionRP of C low highComp Adv. C F

With TradeRP of C rises fallsProduction of C increases

decreasesProduction of F decreases

increases

Trade Equilibrium

The Factor Price Equalization Theorem

• Free trade leads to the international equalization of individual factor prices.

• Wages are equalized across countries even if there is no international mobility of labor.

H F

Initial

Wage low high

Rental high low

With trade

Wage rises falls

Rental falls rises

Why factor prices are NOT equalized internationally?

• List the assumptions of the HO model

• Which of them are crucial for the factor price equalization theorem?

The Stolper-Samuelson Theorem

• In Home, abundant in labor, wages rise while rentals fall with trade. This benefits workers (the abundant factor) and hurts land owners (the scarce factor). – The rise in wage is greater than the increase

in the price of cloth. Thus, real income of workers increases in either good.

– The fall in rental is greater than the fall in the price of food. Thus, real income of capital owners declines in either good.

Political Economy of Trade

Who will be more likely to oppose free trade?a. the owners of scarce factors of production

b. the producers of import-competing products

c. the consumers of export products

Who will be free traders?a. the owners of abundant factors of production

b. the producers of export products

c. the consumers of import products

Gains from trade

• In the HO model, some gain and some lose from trade. Does the nation as whole gain or lose from trade? How to show it?

Trade and Income Distribution

• In the U.S.– High skill labor – abundant factor– Low skill labor – scarce factor

• The wage distribution has become more unequal since the late 70s.

• This is consistent with the Stolper-Samuelson Theorem. Does it mean that trade is responsible for the above trend?

The Leontief Paradox

•