Trade and Resources The HeckscherOhlin model Dr Petre

Trade and Resources The Heckscher-Ohlin model Dr. Petre Badulescu

Introduction This lecture outlines the Heckscher-Ohlin model, a model that assumes that trade occurs because countries have different resources. Our first goal is to describe the Heckscher-Ohlin (HO) model of trade. • The specific-factors model that we studied in the previous lecture was a short-run model because capital and land could not move between the industries. • In contrast, the HO model is a long-run model because all factors of production can move between the industries. Dr. Petre Badulescu Lecture 4, International economics 2

Introduction Our second goal is to examine the empirical evidence on the Heckscher-Ohlin model. • By allowing for more than two factors of production and also allowing countries to differ in their technologies, as in the Ricardo model, the predictions from the Heckscher-Ohlin model match more closely the trade patterns in the world economy today. The third goal of the lecture is to investigate how the opening of trade between the two countries affects the payments to labor and to capital in each of them. Dr. Petre Badulescu Lecture 4, International economics 3

The Heckscher-Ohlin Model Assumptions Assumption 1: Two factors of production, labor (L) and capital (K), can move freely between the industries. Assumption 2: Shoe production is labor-intensive; that is, it requires more labor per unit of capital to produce shoes than computers, so that LS /KS > LC /KC. Dr. Petre Badulescu Lecture 4, International economics 4

The Heckscher-Ohlin Model Assumptions Labor Intensity of Each Industry The demand for labor relative to capital is assumed to be higher in shoes than in computers, LS/KS > LC/KC. FIGURE 4 -1 These two curves slope down just like regular demand curves, but in this case, they are relative demand curves for labor (i. e. , demand for labor divided by demand for capital). 0 Dr. Petre Badulescu Lecture 4, International economics 5

The Heckscher-Ohlin Model Assumptions Assumption 3: Foreign is labor-abundant, by which we mean that the labor–capital ratio in Foreign exceeds that in Home, L*/K*> L/K. Equivalently, Home is capital-abundant, so that K/L >K*/L*. Assumption 4: The final outputs, shoes and computers, can be traded freely (i. e. , without any restrictions) between nations, but labor and capital do not move between countries. Dr. Petre Badulescu Lecture 4, International economics 6

The Heckscher-Ohlin Model Assumptions Assumption 5: The technologies used to produce the two goods are identical across the countries. Assumption 6: Consumer tastes are the same across countries, and preferences for computers and shoes do not vary with a country’s level of income. Dr. Petre Badulescu Lecture 4, International economics 7

APPLICATION Are Factor Intensities the Same across Countries? While much of the footwear in the world is produced in developing nations, the United States retains a small number of shoe factories. In India, the sewing machine used to produce footwear is cheaper than the computer used in a call center. Footwear production in India is labor-intensive as compared with the call center, which is the opposite of what holds in the United States. This example illustrates a reversal of factor intensities between the two countries. In the United States, agriculture is capital-intensive. In many developing countries, it is labor-intensive. ■ Dr. Petre Badulescu Lecture 4, International economics 8

The Heckscher-Ohlin Model No-trade equilibrium FIGURE 4 -2 (1 of 3) No-Trade Equilibria in Home and Foreign 0 0 The Home production possibilities frontier (PPF) is shown in panel (a), and the Foreign PPF is shown in panel (b). Dr. Petre Badulescu PPF: s, Indifference Curves, and No-Trade Equilibrium Price Because Home is capital abundant and computers are capital intensive, the Home PPF is skewed toward computers. Lecture 4, International economics 9

The Heckscher-Ohlin Model No-trade equilibrium FIGURE 4 -2 (2 of 3) 0 PPF: s, Indifference Curves, and No-Trade Equilibrium Price No-Trade Equilibria in Home and Foreign (continued) 0 Home preferences are Theslope Home of no-trade an indifference (orsummarized autarky) curve equilibrium The isslope at the oftangency the PPF point equals A, the by the indifference curve, U. consumers equals where theamount relativethat price consumers that are opportunity are willing tocost payofforproducing one moreone willing computer to pay equals for computers the opportunity in terms cost of of producing more computer it. in terms of shoes rather than dollars. a low relative price given up. The flat slope indicates of computers, (PC /PS)A. Dr. Petre Badulescu Lecture 4, International economics 10

The Heckscher-Ohlin Model No-trade equilibrium FIGURE 4 -2 (3 of 3) PPF: s, Indifference Curves, and No-Trade Equilibrium Price No-Trade Equilibria in Home and Foreign (continued) A* 0 0 Foreign preferences is labor-abundant and shoes by the indifference curve, U* summarized The result from are comparing the no-trade equilibria for these two are laborintensive, so the Foreign Thecountries Foreign no-trade is at theprice tangency point A*, atwith a higher is that theequilibrium no-trade relative of computers Home is PPF is skewed toward shoes. relative lowerprice thanofincomputers, Foreign. as indicated by the steeper slope of (P*C /P*S)A*. Dr. Petre Badulescu Lecture 4, International economics 11

The Heckscher-Ohlin Model Free-trade equilibrium We are now in a position to determine the pattern of trade between the two countries. We proceed in several steps. First, we consider what happens when the world relative price of computers is above the no-trade relative price of computers at Home, and trace out the Home export supply of computers. Second, we consider what happens when the world relative price is below the no-trade relative price of computers in Foreign, and trace out the Foreign import demand for computers. Finally, we put together the Home export supply (Sx) and the Foreign import demand (Dm) to determine the equilibrium relative market price of computers with international trade. Ch 041. pptx Dr. Petre Badulescu Lecture 4, International economics 12