Lecture 3: Chapter 5-7 - Hecksher-Ohlin (H-O) Theory Flashcards
Ricardian Bottom Line
- 2x2 model, 1 input, specialization in comparative advantage good or no trade at all.
- Driven by technological differences (If no technological differences, no trade).
- ## If trade, everybody wins.
Hecksher - Ohlin (H - O) Model
- Two factors of production (land and labor) are used to produce commodities.
- The ratio of the quantity of capital to the quantity of labor used in a production process varies.
- Countries have different endowments of capital and labor available for use in the production process.
- Trade arises out of differences in relative factor abundancy between countries
H - O Model Shows . . .
- Trade is advantageous for both countries.
- Trade characterizes effects on prices, wages, and rents.
- Movement from autarky to free trade, leads to an increase in aggregate efficiency.
H - O Capital
- Physical machines and equipment that are used in production: machine tools, conveyers, trucks, forklifts, computers, office buildings, office supplies.
- Private ownership of Capital assumed
Capital to labor ratio
Ratio of the quantity of capital to the quantity of labor used in a production process.
Capital Intensive
An industry is capital intensive relative to another industry if it has a higher capital-labor ratio in the production process.
Labor Intensive
An industry is labor intensive relative to another industry if it has a higher labor-capital ratio in the production process.
The H - O model shows
- Trade is advantageous in both countries.
- Trade characterize effects on prices, wages, and rents.
- Movement from autarky to free trade, leads to an increase in aggregate efficiency.
Four main theorems in H - O model
- Hecksher Ohlin theorem
- Stolper-Samuelson theorem
- Rybczynski theorem
- The factor-price equalization theorem
Capital Abundant
A country is capital abundant relative to another country if it has a higher capital endowment per labor endowment than the other country.
Labor Abundant
A country is labor abundant relative to another country if it has a higher labor endowment per capital endowment than the other country.
H - O Model Assumptions
- Perfect competition in all markets
- Two-country, two-good (clothing and steel), two-factor (labor and capital)
- Goods are exchanged in a barter economy
- Goods are exchanged in a barter economy
H - O Model Assumptions Continued
- The total amount of labor and capital used in production is limited to the endowment of the country (labor and capital)
- Countries differ in their factor abundances
- Factor owners are the consumers of the goods
- The H-O model is a general equilibrium model (Trade flows will rise until the prices of both goods are equalized in the two markets.)
Stolper - Samuelson theorem
A theorem that specifies how changes in output prices affect factor prices in the H-O model. It states that an increase in the price of a good will cause an increase in the price of the factor used intensively in that industry and a decrease in the price of the other factor.
Fixed proportions production function
- The capital-labor ratio in each production process (within industry) is fixed.
- The unit factor requirements are exogenous to the model and are fixed.
- The capital - labor ratios are fixed.
Variable production function
- Capital-labor ratio used in the production process (within industry) is endogenous.
- Capital-labor ratio will vary with changes in the factor prices.
The Production Possibility Frontier (PPF) —
Fixed Proportions
- The PPF is the set of output combinations that generates full employment of resources (labor and capital).
- Under fixed proportions the full employment PPF is a single point.
The Factor-Price Equalization Theorem
- When the prices of the output goods are equalized between countries, as when countries move to free trade, the prices of the factors (capital and labor) will also be equalized between countries.
- Free trade will equalize the wages of workers and the rents earned on capital throughout the world.
Rybczynski theorem
A theorem that specifies how changes in endowments affect production levels in the H-O model. It states that an increase in a country’s endowment of a factor will cause an increase in the output of the good that uses that factor intensively and a decrease in the output of the other good.
