Chapter 8 HeckscherOhlin Model Winners

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Chapter 8 - Heckscher-Ohlin Model - Winners
Losers from Trade

• This model examines who benefits and who loses
  from trade and why?
• there is a basis for trade any time there are
  difference in supply and/or demand conditions
  between two countries
• in this model the difference is in each countrys
  endowment of a particular factor.
• basic idea, country will export good that uses
  intensively the factor with which the country is
  relatively well endowed.

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Assumptions of model

• 1. two countries, two homogeneous goods, two
  homogeneous factors of production
• 2. technology is identical between countries
• 3. production is constant returns to scale for
  both commodities in both countries
• 4. two commodities have different factor
  intensities , and the relative factor intensities
  are the same for all price ratios
• 5. tastes and preferences are the same in both
  countries

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Assumptions continued

• 6. perfect competition exists in both countries
• 7. Factors are perfectly mobile within each
  country and not mobile between countries
• 8. There are no transportation costs
• 9. There are no policies restricting the
  movement of goods between countries or
  interfering with the market determination of
  prices and output

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Factor abundance in various countries
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Commodity Factor intensity and H-O

• production in one good is intensive in a factor
  when it uses that factor more intensively than a
  second factor in comparison to the relative use
  of the two factors in the production of a second
  good
• K/L in (1)gtK/L in 2 - good one is capital
  intensive

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Examples of Commodities and factor intensities
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Edgeworth box and factor abundance

• In the Edgeworth box diagram, factor endowments
  are represented by the length of the box. If
  there is more labour in country 2, the box for 2
  is wider than for country 1.

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Trade with identical tastes and technology

• Trade can take place with both identical tastes
  and technology,
• if factor endowments are different, then the ppf
  also differs by country

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Relative product and factor prices

• If the product prices in autarky are such that in
  country 1, the price of the good that uses labour
  intensively is higher than the price of the good
  that uses capital intensively, then in country 1
  w/r is greater than in country 2.

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Factor and price adjustments

• Every relative price in the OUTPUT market is
  associated with a corresponding relative price in
  the production INPUT market
• A price change in the output market therefore
  results in a corresponding price change in the
  input market
• Trade doesnt affect the supply of inputs (or at
  least not enough to dominate the overall price
  effect)
• Trade directly affects the demand for inputs
  because these depend on the demand for outputs

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• With trade, demand for the labour intensive good
  (for the country that has a comparative advantage
  in that good) increases the wage in the country
• Therefore, the most abundant factor benefits most
  from trade.

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Producer Adjustment to Changing Relative Prices

• Example Labour abundant country
• The increase in demand for labour intensive goods
  (from exports),
• increases the demand for labour in the country
  and
• increases the price of labour relative to capital
• Because there is more of the labour intensive
  good being produced, and because the wage is
  higher,
• Production becomes less labour intensive in the
  country. (NOTE all labour is employed)

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Producer Adjustment to Changing Relative Prices

• The increase in demand for the labour intensive
  good raises the relative price of labour.(w/r)0
  to (w/r)1
• In production of both goods, this results in less
  labour being used per unit of output.
• However, there is an increase in output of the
  labour intensive good

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General Equilibrium Adjustment
In country 2, more cloth is produced, less
steel is produced, (w/r) rises.

• In country 1,
• more steel is produced,
• less cloth is produced,
• (w/r) falls.

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Stolper-Samuelson Theorem

• (also known as the factor-price equalization
  theorem)
• If all the assumptions of the H-O model hold
  (e.g. under very specific conditions about the
  market and technology),
• the relative price of factors will equalize in
  the two trading countries
• e.g. with trade (w/r)I (w/r)II

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• As price ratios move closer, so do factor prices
• If all assumptions do not hold, some movement may
  be expected, but not equality

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Linking the depictions of trade effects

• First, recall that factor intensity is different
  by industry cloth labour intensive (K/L lower
  at all input prices w/r)
• factor intensity is same for each country (at any
  given w/r ratio

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Country may be Capital-abundant or Labour abundant

• Either K/L higher in capital abundant, or
• with no trade, (w/r) higher in capital abundant
  country
• In the graph below, (w/r)0 represents before
  trade wage/rental ratio

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Here we have a country that is labour
abundantRELATIVE to partner

• Trade allows labour abundant country to export
  labour intensive good and import capital
  intensive good.

Steel
Pc/Ps
Pc/Ps
Cloth
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Labour abundant country adjustment to trade

• with no trade, (w/r)0 lower in labour abundant
  country
• with trade, more demand for labour as production
  of labour-intensive good (Cloth) expands
• (w/r)1 is equal across trading countries IF all
  H-O assumptions hold