Week 3: Hecksher Ohlin Theory Flashcards
What does the Hecksher-Ohlin theory argue?
6 Assumptions of the Two factor Hecksher-Ohlin Model
- Labour and land are the only two resources used in production
- The amounts of labour and land vary across countries, and this variation influences productivity
- The supply of labour and land in each country is constant (Given). The two resources are fully used (no unemployment and no unused land)
- Only two goods are important for production and consumption cloth and food
- Both factors are mobile across industries but not mobile across countries
- Only two countries are modelled home and foreign
What are the land and labor constraints?
- There are now 2 constraints instead of one there is labour and land
- Land constraint: Total amount of land is ≥ Land needed for each unit of production multiplied by the total units of food production + Land required for each unit of cloth production multiplied by the total units of cloth production
- Labour constraint: Total amount of labor resources = Labour required for each unit of food production multiplied by the quantity of food produced + the labor requirement for one unit of cloth multiplied by the total quantity of cloth produced
Explain what cloth production being labor-intensive means and food being land-intensive means and represent this with an equation
Diagram and an explanation of a PPF when there is no factor substitution
- 2 different constraints labor and land constraints
- The triangles to the left of the curves represent the constraints of each and we need to satisfy both therefore it needs to be where the two constraints overlap represented by the red line which is no longer a straight line and is a kink representing a kinked PPF
- The PPF being kinked means that the opportunity cost now changes
- The opportunity cost is low when the economy produces a low amount of cloth and a high amount of food as when you increase the production of cloth by one unit there is only a small fall in the production of food. (You lose small ammount of food therefore opportunity cost is low)
- The opportunity cost is high when the economy produces a high amount of cloth, giving up one unit of cloth will mean you can produce a large amount of food therefore the opportunity cost is higher.
- If an economy already produces a lot of cloth you are quite happy to give up a bit of cloth as you get a lot of food back in return. Similarly, if u produce no cloth you are happy to produce give up a bit of food as it means you produce a lot of cloth
Isoquant diagram and an explanation
- Substitutability of factors of production can be represented by an isoquant which shows all the combinations of two inputs that produced a given amount of output
At what point should an economy produce
What is the value of production V equal to?
A bit about defining an isovalue line
Diagram maximizing the value of production subject to the PPF
Diagram maximizing the value of production subject to the PPF
What is the Stolper Samuelson theorem
- Under perfect competition the price of a good equals the cost of production and the cost of production depends on the wage rate and rental ratio
- There is a positive relationship between relative prices of goods and input prices of good
- If the relative price of cloth increases, then the factor used intensively which is labour and therefore wages the price of wages will increase whilst the price of the other factor which is the rental cost will decrease
Plot and explain a double diagram showing the relationship among factor prices and good prices and the levels of factors used in the production
See notes for more detail
LHS represents the SS theorem. As w/r increases the relative price of cloth increases as labour costs are higher
RHS: Food industry more to the right as it uses land more intensively. Both curves upwards sloping an increase in w/r leads to an increase in the land to labour ratio as firms substitute labour for land as labour costs are higher now
Explain what an increase in the relative price of cloth will do and the final step being the implication for income distributions
- An increase in the relative price of cloth will lead to an increase in the wage rate relative to landowners as w/r goes up as a higher relative price of cloth signals to produce more therefore more workers are needed leading to an increase in w relative to r. This is also good for workers in the food industry as labor is mobile in both industries and therefore will equalise so wages for both types of workers increase
- Land owners real income goes down as the price of cloth relative to food has increased so price of food is essentially lower
- Thus, changes in the relative price have such a strong effect on income distribution that owners of one production factor gain, while owners of the other are made worse off.
- In the Ricardian we only had 1 agent this one we have 2 agents and therefore there is one which is made better and worse off
Diagram summarising the relationship between the factor levels used in production and output levels
- Black ray shows the land labor ratio for cloth industry and the red ray shows the land labor ratio foe the food industry
- Land labor ratio is higher for the food industry due to the assumption that its intensive in land and Lower for cloth.
- This is drawn for a given relative pric, if we change the relative price then the slopes will change and therefore there would be a different intersection
Diagram showing how trade leads to a convergence of relative prices
- Relative demand is same in both countries by assumption
- Point 1: RS is more towards the right as the relative quantity of cloth produced is higher and the relative price of cloth for the home economy is lower as there is greater quantit
- Point 3: This represents the foreign equilibrium which is to the left as it produces relatively more food compared to home and the relative prices of cloth are higher and the relative quantity of cloth produced is lower
- No we assume free trade
- With free trade relative price of cloth will rise in home as its being exported and therefore will signal to produce more leading to a higher w and therefore a higher price of cloth and the price in foreign will fall as they are importing it now for cheaper
- This leads to prices being somewhere between 1 and 3
Diagram showing how trade expansionists the economies consumption possibly frontier
- Initially consuming at point 2
- Because of trade we can consume in the blue region which means we are able to consume more of both goods due to specialisation and trade.
