Heckscher-Ohlin Model PDF

2. The Heckscher – Ohlin model Chapter 4 and 5 in Pugel, T. A. International Economics, 17th Edition Trade: factor availability and factor proportions are key Drawback to Ricardo’s approach - assumption of constant marginal opportunity costs Example: expansion of wheat production would run...

2. The Heckscher – Ohlin model Chapter 4 and 5 in Pugel, T. A. International Economics, 17th Edition Trade: factor availability and factor proportions are key Drawback to Ricardo’s approach - assumption of constant marginal opportunity costs Example: expansion of wheat production would run into rising costs due to limits on: how much more land could be drawn into wheat production and how suitable it would be for wheat production availability of additional workers willing and suitable to work on the farms availability of seeds, fertilizers, and other material inputs Production with increasing marginal costs More realistic assumption: as one industry expands at the expense of others, increasing amounts of the other products must be given up to get each extra unit of the expanding industry’s product What’s behind the Bowed-Out Production-Possibility Curve? There are several kinds of factor inputs (land, skilled labor, unskilled labor, capital, and so forth) Different products use factor inputs in different proportions Wheat-and-cloth example: Wheat uses relatively more land and less labor than cloth. The cloth industry will release a lot of labor and not much land. To employ these factors, the wheat industry must shift toward using more labor-intensive techniques. Thus, fewer and fewer extra units of wheat production are gained by each extra unit of lost cloth production What production combination is actually chosen? Assumption: market price of cloth in terms of wheat is 2 W/C If the opportunity cost of producing another unit of cloth is less than the 2 W/C, then try to make more cloth (and take resources away from wheat) If the opportunity cost of producing another unit of cloth is more than the 2 W/C, then try to make less cloth (and shift resources into growing wheat) If the opportunity cost of producing another unit of cloth is equal to the 2 W/C, then you are producing the right amount Community indifference curves Indifference curve - various combinations of consumption quantities that lead to the same level of well-being or happiness Budget constraint (dashed colored line) highest feasible well-being at point D Community indifference curves - how the economic well-being of a whole group depends on the whole group’s consumption of products Production and consumption together: without trade Indifference Curves and Production Possibilities without Trade - Without trade, the best an economy can do is to move to the production point that touches the highest community indifference curve. This best no-trade point is S0 , where the nation both produces and consumes, reaching indifference curve I1. Production and consumption together: with trade Two ways to portray a free-trade equilibrium trade between two countries for two products, with each country producing at its point S1 and consuming at its point C1 (upper panel) using supply and demand curves that focus on one product (cloth, the lower panel) What determines the trade pattern? Product prices differ with no trade because Production conditions differ Demand conditions differ Some combination of these two differences. The Heckscher–Ohlin (H–O) theory A country exports the product (or products) that uses its relatively abundant factor(s) intensively and imports the product (or products) that uses its relatively scarce factor(s) intensively Consider labor: A country is relatively labor-abundant if it has a higher ratio of labor to other factors than does the rest of the world A product is relatively labor-intensive if labor costs are a greater share of its value than they are of the value of other products. Example: the United States exports wheat and imports cloth because wheat is land-intensive and cloth is labor-intensive 𝑈𝑆 𝑙𝑎𝑛𝑑 𝑠𝑢𝑝𝑝𝑙𝑦 𝑅𝑒𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑤𝑜𝑟𝑙𝑑 ′ 𝑠 𝑙𝑎𝑛𝑑 𝑠𝑢𝑝𝑝𝑙𝑦 > 𝑈𝑆 𝑙𝑎𝑏𝑜𝑟 𝑠𝑢𝑝𝑝𝑙𝑦 𝑅𝑒𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑤𝑜𝑟𝑙𝑑 ′ 𝑠 𝑙𝑎𝑏𝑜𝑟 𝑠𝑢𝑝𝑝𝑙𝑦 Short-run effects of opening trade All groups tied to rising sectors gain (higher demand for the factors: labor, land, and other inputs) All groups tied to declining sectors lose (reduced demand and therefore reduced prices for their services). How free trade affects income distribution in the long run: the whole chain of influence Winners and Losers: Short Run versus Long Run Reminder: The gains and losses to the different groups do not cancel out leaving zero net gain. In the long run, both countries get net gains. In the short run, net national gains or losses depend partly on the severity of any temporary unemployment of displaced factors Three implications of the H–O theory The Stolper–Samuelson Theorem - an event that changes relative product prices in a country has two effects: It raises the real return to the factor used intensively in the rising-price industry. It lowers the real return to the factor used intensively in the falling-price industry. The Specialized-Factor Pattern - broader pattern, one that tends to hold for any number of factors and products The more a factor is specialized, or concentrated, in the production of a product whose relative price is rising, the more this factor stands to gain from the change in the product price. The more a factor is concentrated into the production of a product whose relative price is falling, the more it stands to lose from the change in product price. The Factor-Price Equalization Theorem - free trade equalizes not only product prices but also the prices of individual factors between the two countries Does Heckscher–Ohlin explain actual trade patterns? The Leontief paradox - In 1947, the United States (capital- abundant, and labor-scarce) was exporting relatively labor- intensive goods to the rest of the world in exchange for relatively capital-intensive imports! The key ratio (Kx/Lx)/(Km/Lm) was only 0.77 Complete tests require information on the factor endowments trade patterns In general, trade patterns fit the H–O theory reasonably well but certainly not perfectly Factor Endowments International trade The factor content of US Exports and competing imports The factor content of Canada’s Exports and competing imports Do factor prices equalize internationally? The real world is not fully consistent with the theorem Although we still do not see full factor-price equalization in the real world, there appear to be tendencies toward equalization