Chapter 3: Heckscher Ohlin Model Flashcards
Whats the difference btw the Ricardian Model and the HO Model?
Ricardian model where countries’ comparative advantage arises from different labor productivity across countries.
The Heckscher-Ohlin model builds on the idea that countries’ comparative advantage arises from different endowments of factors of production, and that production of different goods uses production factors (input) with different intensity.
What happens when there are two or more factors of production?
there are decreasing returns to each factor which typically implies incomplete specialization.
Thus when countries have the same prodcution technology, they will use different proportions of factors when producing goods
What are the assumptions of the HO model
2 countries: Home and Foreign. We will start by analyzing only one country: Home.
2 goods: X and Y , or clothing and food.
2 factors of production: labor L and capital K
The two countries have access to the same technologies to produce the two goods (with constant returns to scale in production and diminishing marginal returns).
There is constant supply of resources and endowments differ across countries. In the long run, both labor and capital can move across sectors, equalizing their returns (wage and rental rate) across sectors. There is no international factor mobility.
Perfect competition prevails in all markets (goods and factors). Factors can move freely between sectors, but cannot move between countries.
In equilibrium, all resources are used (factor markets clear), so there is no unemployment or excess capital.
What is an isoquant?
What are isocost line. What is the slope of the line?
An isoquant shows the bundles of capital and labor that can be used to produce the same level of output of a good.
An isocost line shows the combinations of factors (K and L) that cost the same amount –> Isocost line have the slope -w/r
What is the minimum amount of capital and labour to produce one unit of X?
When are cost minimised?
unit cost function:
cX(w,r) = waLX(w,r)+raKX(w,r).
Cost are minimised when the isoquant is tangent to the isocost line
MPLx/MPKx = w/r
What is the unit isocost line
What are unit-value isoquants?
Shows the combinations of capital and labour inputs that generates a production cost of 1 dollar
Unit-value isoquants: A pair of isoquants showing given amounts of good X and good Y that sell for exactly 1 dollar in world markets.
How do producers of X and Y maximise their profits?
What is the first order condition?
πX = maxL,K pXQX −wXLX −rXKX where QX = FX(LX,KX) and
πY =maxL,K pYQY −wYLY −rYKY whereQY =FY(LY,KY).
In this case, perfect condition, producers maximising profits means that they earn zero profits
FOC:
MPLx/MPKx = Wx/Rx
How to show good x is the capital intensive good?
Kx/Lx > Ky/Ly
Lx/Kx < Ly/Ky
Y axis: Wage-rental ratio
X axis: Labour-Capital ratio
For any given wage/rental ratio, production of good Y requires more labor relative to capital than production of good X.
How to calculate wage rate and rental rate for both goods
wX =wY ⇒pXMPLX =pYMPLY ⇔ pX = MPLY
rX =rY ⇒pX * MPKX =pY * MPKY ⇔ pX/pY = MPKY / MPKX
What is the factor markets equilibrium
1) Zero Profit Conditions (P=MC)
Px = waLX(w,r)+raKX(w,r) = cX(w,r)
Py = waLY (w,r) + raKY (w,r) = cY (w,r)
2) Resource Conditions
L=LX +LY =aLX(w,r)X+aLY(w,r)Y
K=KX+KY =aKX(w,r)X+aKY(w,r)Y
What is factor intensity
Factor intensity of industry X is denoted by kX = KX /LX
The optimal factor choice to produce one unit of a good aLX(w,r) and aKX(w,r) yields factor intensity aKX (w, r)/aLX (w, r).
What is the cone of diversification
If an economy produces both goods, the country’s endowment of labor (L) and capital (K) must be within the cone of diversification.
OA is the total amount of labour and capital used in industry X and OB is the total amount of labour and capital used in industry Y
What happens when there is an increase in relative price of x to y
What happens to labour and capital allocation
MPKy/MPK
pX/Py ↑ must mean that MPLy/ MPLx increases.
As there are diminishing returns to labour, labour moves from good Y to good X production –> Ly decreases, Lx increases
pX/Py ↑ must mean that MPKy/ MPKx increases.
There are dimishing returns to capital, so this means capital move from good Y to good X
An increase in pX causes both labor and capital to move from labor intensive good Y to capital intensive good X production.
