Trade and Resources Heckscher Olin Model Flashcards
Conditions in HO model
- 2 goods
- 2 countries
- 2 input factors: labour and capital
- labour and capital are employed and mobile across industries - Identical preferences
- Free trade
- Balanced trade - imports = exports
7.Resources are different across countries, factor intensities are
different across industries.
Opportunity cost in HO
PPF - Various combinations of goods that are produced with all resources
and efficient technology.
PPF for is
skewed in the direction of abundant factor
OC of X is the units of Y forgone to produce one unit of X.
OC of abundant factor increase as there is more of it
Autarky Equilibrium
PPF as the income budget of a country
Higher indifference curves means higher utility and welfare
Tangent between PFF and IC is equilibrium - production, consumption point
Relative Prices
The relative price of X is equal to the absolute value of the slope of the PPF.
Whatever slope is greater at X when IC and PPF meet , that country will export their goods
HO theorem
Each country will export the goods that uses intensively the factor of production it has in abundance and will import the other goods.
Factor abundance of countries and factor intensity of industries determine trade pattern.
Free trade and world price
World price is determined by the world market demand and supply
World price is exogenously given
Diversification: Production
- World price of X is larger than Home price and lower than F price
- For H, X is more expensive in world market. H will sell X in world market
- Since country H exports X, country H must produce more X.
Therefore the production point of country H moves along the PPF
until the OC of X is equal to the world price of X. - H will still diversify at this point due to increasing OC, there is no specialisation
Trade Equilibrium: Consumption
Because of opportunity to trade, the budget (PPF) is relaxed
The new budget in free trade becomes the world price line
The free trade equilibrium is the the tangent between new pushed out PPF and IC.
Trade Triangles
1) Country H’s export of X is equal to country F’s import of X.
BD = C∗D∗
(2) Country F’s export of Y is equal to country H’s import of Y.
CD = B∗D∗
(3) Two trade triangles should be the same. Refer to the figure:
∆BCD = ∆C∗B∗D∗
Trade Gains
Both countries are better off because they have arrived at higher ICs
In Autarky this would not be attainable but due to free trade it is.
Winners and losers from international trade however.
SS Theorem
An increase in the relative price of a good will
increase the real earnings of the factor used intensively in the production of that good and decrease the real earnings of the other
factor.
As the relative price of the abundant factor increases, the opposite will decrease due to a decrease in the production of Y.
Due to the slope of the curve X will absorb capital faster than Y can release it, leading to a shortage of that factor and high demand and small supply causes prices to rise.
Whoever has abundant factor will gain while the other loses.
Implications of HO model compared to Ric Model
Re-distributional effects from trade
Those who support the trade and those who don’t
If capital owners are rich and workers are poor, trade can increase income inequality
Considering skilled and unskilled labour as the two factors,
trade can increase skill premium in country that is abundant in skilled labour.
Leontief’s Paradox explained
Tech isn’t the same in real world
More factors than labour and capital
Skilled labour/ Human capital
- US labour has more skills, thereby increasing their productivity and
making their exports skilled-labour intensive.
If the preferences differ across countries, the pattern of comparative
advantage could be reversed.
Differences between HO and Ricardian
One factor in Ricardian model and two factors in HO model.
(2) Linear PPF in Ricardian and bowed out PPF in HO model: constant OC
vs increasing OC.
(3) In Ricardian Model, technology differences are the basis of trade; in HO
model, factor endowments are the basis of trade: CA vs HO Theorem
(4) Under free trade, there is specialization in Ricardian model and diversification in HO model.
(5) In Ricardian model, the only factor, labour, gians from trade. In HO
model, there are two factors, the abundant factor gains from trade (winners)
while the other factor has a loss (losers).
Similarities between HO and Ricardian
(1) Common assumptions: 2 goods, 2 countries, factors mobile across industries and not mobile across countries, factors fully employed, identical
preferences, free trade, balanced trade
(2) Trade pattern is determined by relative prices in autarky, which are
decided by OC in autarky (slopes of PPF). A country exports the product
it has lower OC (lower prices) in autarky (the product it has CA in) and
imports another product.
(3) Both countries have overall gains from trade.
