Lecture 3
THE HECKSCHER-OHLIN MODEL
1. Assumptions
- Two countries: Home and Foreign
- Two goods: Cloth (C) and Jet engines (J)
- Two factors: Labor (L) and Capital (K)
- Factor mobility across industries
- Perfect competition
- Full employment
1.1 Basic version of the model
- Fixed input-output coefficients: aLC, aLJ, aKC, aKJ
- Assume that Cloth production is labor-intensive; Jet engine production is capital-intensive:
2. Production possibilities
Labor is fully employed: LC + LC = L
Capital is fully employed: KC + KC = K
Given L and K, determine output of Cloth and Jet engines:
aLCQC + aLJQJ = L
aKCQC + aKJQJ = K
3. The Rybczynski Theorem
At constant prices, an increase in the endowment of labor (resp., capital)
will lead to:
- An increase in the output of the labor-intensive good (resp.,
capital-intensive good), and
- A decrease in the output of the capital-intensive (resp.,
labor-intensive) good.
4. Output prices and input prices
Perfect competition in Cloth and Jet engine markets
Zero profits in each industry
Price = Average Cost, in each industry:
aLCw + aKCr = PC
aLJw + aKJr = PJ
Given output prices, determine factor prices
5. Stolper-Samuelson Theorem
An increase in the price of the labor-intensive good will lead to:
- An increase in the price of labor, and
- A decrease in the price of capital
6. The general version of the H-O model
Variable input-output coefficients
Input substitution by firms
Concave (bowed-out) PPF
Rybczynski theorem and Stolper-Samuelson theorem hold (PHEW!)
6.1 Factor endowments
Assume that Home has higher ratio of labor to capital than Foreign, i.e. Home is labor-abundant
Recall: Cloth is assumed to be the labor-intensive industry
6.2 Relative prices
- Sketch PPFs for Home and Foreign
- The autarkic relative price of Cloth in Home is [ greater / less ] than that in Foreign. (Why?)
7. Autarky
- Obtain autarkic relative price in Home and Foreign
- Indifference curve is tangent to PPF; slope of each equals the autarkic price
8. International trade
- Sketch import demand and export supply curves for Cloth:
MC* = QC* - DC*
XC = DC - QC
- Obtain world (relative) price of Cloth (PC / PJ)
9. Pattern of trade
- Home exports cloth (the labor-intensive good)
- Foreign exports jets (the capital-intensive good)
10. Gains from trade
- Show that both Home and Foreign are better off
11. Income distribution
- Use the Stolper-Samuelson theorem
- What is the effect of trade on w and r in each country?
12. Factor Price Equalization
- If both goods are produced by each country, and trade leads to
identical output prices in both countries, factor prices will become equal in both countries, i.e:
- Factor price equalization will not occur if:
- Countries specialize in production
- Countries have different technology
- Output prices do not converge after trade
13. Leontief Paradox
The U.S. is relatively abundant in capital, yet ....
.... U.S. exports are less capital-intensive than its imports!
How come?
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