The Hecksher-Ohlin Model of Trade

Question 1

What are the assumptions of this model?

Answer 1

Identical homothetic preferences
2 countries: home and foreign*
2 goods: x and y
No trade costs

Question 2

HO Production

Answer 2

• Perfect Competition
• Constant returns to scale: Double inputs, double outputs
• Identical technology across countries
• Each good produced using two factors
  L- Labour
  K- Capital
  Both exogenously endowed
  Two “types of people
  skilled + unskilled

Question 3

What does abundance mean?

Answer 3

The relative size of endowments

Question 4

K/L > K/L
Which country is abundant in what?

Answer 4

• Home is Capital (K) abundant
• Foreign is Labour (L) abundant

Question 5

Can a country have an abundance in one or both factors?

Answer 5

A country can have a size advantage in both factors but only an abundance in one

Question 6

How much K and L is needed to make one unit of output? - Ricardian Model

Answer 6

Ricardian: Direct from the production function because just one input

Question 7

How much K and L is needed to make one unit of output? - HO

Answer 7

HO - Many ways to make output so how to choose?

Question 8

Cost function

Answer 8

wL + rK
MPL/MPK = w/r
wage - w
rental rate - r
Different combinations of K and L make 1x.
Pick the cheapest - where the slope of the cost line = slope of isoquant

Question 9

Marginal Rate of Technical Substitution

Answer 9

ratio of factor prices
fl/fk = w/r

Question 10

Factor price differences drive what?

Answer 10

output price difference which drives opportunity cost

Question 11

What should you be careful not to confuse?

Answer 11

Don’t confuse factor abundance with factor intensity
Countries:
K/L vs. K/L
Goods:
K/Lx vs. K/Ly

Question 12

Kx > Ky

Answer 12

X is K intensive
Y is L intensive

Question 13

Substitution Cost

Answer 13

K and L are not perfect substitutes within good.
Goods are not perfect substitutes for each other in production

Question 14

PPF

Answer 14

• Starting from all y, zero opp cost of x.
• Opp cost rises the more x you make
• Hits infinity at all x, no y

Question 15

To maximize profit

Answer 15

Hit highest revenue line you can given tech + endowment
-> GDP
As long as prices are between 0 and infinity, make both goods

Question 16

Do firms ever have complete specialization?

Answer 16

Never complete specialization

Question 17

Autarky - PPF

Answer 17

Reach the highest IC you can given your PPF
These goods prices are matched with factor prices
Prices reflect opportunity cost

Question 18

Relative demand is the same for who?

Answer 18

home, foreign and the world as a whole

Question 19

What does the HO model of trade link comparative advantages to factor endowments by linking what?

Answer 19

by linking technology, factor prices and factor demands
- This is found by cost minimization

Question 20

Graphically, the cost-minimizing combination of capital and labour is where what is tangent to what?

Answer 20

the isoquant is tangent to the lowest iso-cost curve. Mathematically, this is found using two equations: MPl/MPk = w/r and f(K,L) = Q.

Question 21

What does the capital-labour ratio summarize?

Answer 21

The optimal mix of capital and labour

Question 22

What does capital intensive mean?

Answer 22

If the capital-labour ratio of good X is greater than that for good Y, then we say that X is capital intensive

Question 23

What can be described using an Edgeworth Box?

Answer 23

The factor prices which drive capital intensity

Question 24

What is the cone of diversification?

Answer 24

Information on capital intensity will help us tell when a country will diversify using the cone of diversification

Question 25

What is the Production Possibilities Frontier (PPF)

Answer 25

It looks at the various amounts of X and Y a country can make

Question 26

Why is the PPF bowed out?

Answer 26

The opportunity cost of Y in terms of X goes up the more Y made. Since labour and capital are imperfect substitutes, as we make fewer X and more Y, more and more X must be given up for another Y.

Question 27

What is it called when there is 0 trade

Answer 27

Autarky

Question 28

Under autarky, the optimal bundle is where the slope of the indifference curve, which is known as the Marginal Rate of Substitution (MRS) is equal to what?

Answer 28

the slope of the PPF, which is known as the Marginal Rate of Transformation (MRT)

Question 29

For a given set of prices and income, the optimal bundle is found by setting what equal to what?

Answer 29

MRS = px/py and pxX + pyY = I, where I is the income.

Question 30

Why does the gain from trade arise?

Answer 30

because they will be able to consume outside their PPF.

Question 31

Where do the gains from trade come from?

Answer 31

an exchange and a specialization effect. It is also mutual because countries can choose a terms of trade price which lies between their differing opportunity costs.

Question 32

What can the terms of trade price be found using?

Answer 32

relative supply and relative demand or offer curves, which relate imports to exports

Question 33

What does the HO model assume?

Answer 33

technologies are the same, but that the relative amounts of capital and labour differs between two countries

Question 34

We say a country is capital abundant if

Answer 34

If a country has a higher capital-labour ratio than another (i.e. is endowed with a higher capital-labour ratio)

Question 35

What is The Heckscher-Ohlin Theorem?

Answer 35

A country will tend to specialize in and export the good that uses its relatively abundant factor intensively

Question 36

What is the Stolper-Samuelson Theorem?

Answer 36

When the relative price of a good rises, the wage of the factor used intensively in the production of that good will rise, while the wage of the other factor will fall

Question 37

What is the Rybczynski Theorem?

Answer 37

At fixed prices, when the supply of a factor increases, it will lead to an increase in the production of the good that uses that factor intensively and a reduction in the output of the other good

Question 38

What is The Factor Price Equalization Theorem?

Answer 38

Free trade in goods may lead to the equalization of factor prices, just like trade in factors would

Question 39

What is the Intertemporal Model of Trade?

Answer 39

Intertemporal means over time, so what we are talking about is a country trading goods they make today for goods that they can consume tomorrow. If two countries have different abilities to make goods today versus tomorrow, they will find it optimal to trade. This implies that one country will run a trade deficit today, and a trade surplus tomorrow.

Question 40

What is a trade deficit?

Answer 40

Country consumes more than they make today - importing more than they are exporting

Question 41

What is a trade surplus?

Answer 41

a country makes more than they consume - exporting more than they are importing