Lecture 3: Chapter 5-7 - Hecksher-Ohlin (H-O) Theory

Question 1

Ricardian Bottom Line

Answer 1

• 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.

Question 2

Hecksher - Ohlin (H - O) Model

Answer 2

• 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

Question 3

H - O Model Shows . . .

Answer 3

• 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.

Question 4

H - O Capital

Answer 4

• Physical machines and equipment that are used in production: machine tools, conveyers, trucks, forklifts, computers, office buildings, office supplies.
• Private ownership of Capital assumed

Question 5

Capital to labor ratio

Answer 5

Ratio of the quantity of capital to the quantity of labor used in a production process.

Question 6

Capital Intensive

Answer 6

An industry is capital intensive relative to another industry if it has a higher capital-labor ratio in the production process.

Question 7

Labor Intensive

Answer 7

An industry is labor intensive relative to another industry if it has a higher labor-capital ratio in the production process.

Question 8

The H - O model shows

Answer 8

• 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.

Question 9

Four main theorems in H - O model

Answer 9

1. Hecksher Ohlin theorem
2. Stolper-Samuelson theorem
3. Rybczynski theorem
4. The factor-price equalization theorem

Question 10

Capital Abundant

Answer 10

A country is capital abundant relative to another country if it has a higher capital endowment per labor endowment than the other country.

Question 11

Labor Abundant

Answer 11

A country is labor abundant relative to another country if it has a higher labor endowment per capital endowment than the other country.

Question 12

H - O Model Assumptions

Answer 12

• 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

Question 13

H - O Model Assumptions Continued

Answer 13

• 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.)

Question 14

Stolper - Samuelson theorem

Answer 14

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.

Question 15

Fixed proportions production function

Answer 15

• 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.

Question 16

Variable production function

Answer 16

• Capital-labor ratio used in the production process (within industry) is endogenous.
• Capital-labor ratio will vary with changes in the factor prices.

Question 17

The Production Possibility Frontier (PPF) —

Fixed Proportions

Answer 17

• 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.

Question 18

The Factor-Price Equalization Theorem

Answer 18

• 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.

Question 19

Rybczynski theorem

Answer 19

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.