Chapter 8 - Heckscher-Ohlin Model - Winners

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

• Recall
• there is a basis for trade any time there are
  difference in supply and/or demand conditions
  between two countries
• This model examines who benefits and who loses
  from trade and shows a possible reason for it.

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

• In the Heckscher-Ohlin model the important
  difference is in each countrys endowment of a
  particular factor.
• Endowment can be viewed as a fixed supply of a
  factor.

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

• A country is abundant in a factor if it has
  relatively more of it (compared to the other
  factor) than its partner country.
• Example Argentina is capital abundant compared
  to Benin if
• KA/LA gt KB/LB

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Factor endowments 1992
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Factor endowments

• Looking at the above table, it is likely that
• Canada will import labour intensive goods. It
  will export land intensive goods
• India will export labour intensive goods and
  import capital intensive goods
• Japan will export capital intensive goods and
  import land-intensive goods
• Mexico and the US are in the middle in the three
  columns. Their trade patterns will depend on
  world prices.

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

• Prediction of model country will export good
  that uses intensively the factor with which the
  country is relatively well endowed.
• This will affect the distribution of capital and
  labour in the country, as well as the
  capital/labour ratio used in each industry.

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Assumptions of model

• two countries, two homogeneous goods, two
  homogeneous factors of production
• technology is identical between countries
• production is constant returns to scale for both
  commodities in both countries
• 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 (concentrate on analyzing production)

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Assumptions continued

• perfect competition exists in both countries
• Factors are perfectly mobile within each country
  and not mobile between countries
• 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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Commodity Factor intensity and H-O

• On the next slide, we show the information on
  demand for capital and labour for one industry
• Note
• The line Ks/Ls shows the proportion of capital to
  labour used at these factor prices for a
  homothetic technology.
• Qs is the amount of steel produced
• w/r is the relative prices at which Ks/Ls are
  chosen to produce Qs

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Commodity Factor intensity and H-O

• KS /LS gt KC /LC - steel is capital intensive

Capital
QS
KS/LS
w/r
.
Capital used in steel production, Qs
Labour
Labour used in steel production QS
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Commodity Factor intensity and H-O

• Steel is intensive in capital because it uses
  more capital relative tolabour in comparison to
  the relative use of capital/labour in the
  production of cloth
• KS /LS gt KC /LC - steel is capital intensive
• On the next slide, we show
• isoquants for two products, steel and labour
• factor prices w/r (parallel lines represent same
  factor prices)
• NOTE production levels are not the same for
  these goods. They are two separate industries.
• for w/r, KS /LS gt KC /LC

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Commodity Factor intensity and H-O

• KS /LS gt KC /LC - steel is capital intensive

Capital
QS
KC/LC
KS/LS
KS/LSgtKC/LC
w/r
.
.
Labour
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Factor intensity

• For H-O model to predict trade patterns, it is
  important that factor intensities do not change
  (steel is ALWAYS capital intensive)
• The next slide shows 2 sets of factor prices and
  2 corresponding sets of input choices for each
  industry.
• For both sets of factor prices, steel is capital
  intensive.

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Commodity Factor intensity and H-O

• KS /LS gt KC /LC - steel is capital intensive

KC/LC2
KS/LS2
w/r2
Capital
QS
KC/LC1
.
KS/LS1
KS/LS1gtKC/LC1
w/r1
KS/LS2gtKC/LC2
.
.
.
Labour
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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 II, the box for
  II is wider than for country I.

LI
LII
KI
KI
KII
KII
LII
LI
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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
• Recall Country I is capital intensive, therefore
  its ppf stretches out further along the Steel
  axis than country IIs ppf.

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Trade with identical tastes and technology

• Country I can make more steel and less cloth than
  country II
• Both countries benefit by consuming similar
  amounts (C) but producing different combinations
  of steel cloth trading
• (we showed this in chapter 6)

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Trade with identical tastes and technology

• Left shows different ppfs and different
  consumption points in autarky
• Right shows incomplete specialization and trade
  with common consumption point

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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

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Commodity Factor intensity and H-O

• Pc/Ps1 gt Pc/Ps2 implies w/r1 gt w/r2
• w/r1 gt w/r2 implies (PC/PS)1 gt (PC/PS)2

w/r2
Capital
Pc/Ps
.
QS
QC
Pc/Ps1
.
.
w/r1
Pc/Ps2
.
Labour
w/r
w/r1
w/r2
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Relative product and factor prices

• There is a direct relationship between product
  prices and factor prices. This holds across
  countries as well as for price changes in a
  country.
• If the product prices in autarky are such that in
  country I,
• the price of cloth (labour intensive good) is
  higher than the price of steel (capital intensive
  good)
• then in country I w/r is greater than in country
  II.

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Factor and price adjustments

• 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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Output ant factor price adjustment for labour
abundant country

• With trade, demand for the labour intensive good
  increases the wage in the country
• Therefore, the most abundant factor benefits most
  from trade.

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• Factor price adjustment for labour abundant
  country.
• demand for capital falls
• demand for labour rises
• Supply is constant

SL
SK
r
w
r0
w1
w0
r1
DK
DL
DL
DK
Labour
Capital
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Producer Adjustment to Changing Relative Prices

• Example Labour abundant country
• (Country II)
• 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

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Producer Adjustment to Changing Relative Prices

• 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.

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Understanding decrease in labour intensity

• Assume two goods are being produced toys and
  beer
• A country has 100 units of capital and 200 units
  of labour
• When 50 of each toys beer are produced, the
  country uses
• 40 K and 100 L to produce toys
• 60 k and 100 L to produce beer.

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Understanding decrease in labour intensity

• When 50 of each toys beer are produced, the
  country uses
• 40 K and 100 L to produce toys
• 60 k and 100 L to produce beer.
• Now the country trades and exports toys.
• To produce 75 toys, the country could use

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Understanding decrease in labour intensity

• When 50 of each toys beer are produced, the
  country uses
• 40 K and 100 L to produce toys
• 60 k and 100 L to produce beer.
• To produce 75 toys, the demand and price of
  labour rise
• 65 k and 150 L to produce toys
• 35 K and 50 L to produce beer

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Understanding decrease in labour intensity

• When 50 of each toys beer are produced, the
  country uses
• 40 K and 100 L to produce toys K/L0.4
• 60 k and 100 L to produce beer. K/L 0.6
• To produce 75 toys, the demand and price of
  labour rise
• 65 k and 150 L to produce toys K/L 0.43
• 35 K and 50 L to produce beer K/L 0.7

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Understanding decrease in labour intensity

• The labour intensive good uses relatively more
  labour per unit of capital than the capital
  intensive good.
• Therefore, when a country produces more of it, it
  demands more labour.
• Labour supply is fixed.
• The price of Labour (wage) rises.
• The producers adjust by using less labour per
  unit of capital in the production of all goods.

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Producer Adjustment to Changing Relative Prices

• In country II
• There is an increase in output of the labour
  intensive good
• 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.

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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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Producer Adjustment to Changing Relative Prices

• In country II
• More cloth and less steel leads to both
  industries using more capital intensive
  technology because labour is in high demand in
  cloth production.

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Summary H-O model

• Assuming identical technology tastes
• A country will export the good that intensively
  uses the factor in which the country is abundant.
• When a country moves to trade, its production
  will become less intensive than before trade
• (due to the increase in production of the good
  that uses the abundant factor intensively).

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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

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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 rises to (w/r)1

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w/r different in autarky depending on abundant
factor

• Either K/L higher in capital abundant, or
• with no trade, (w/r)0 higher in capital abundant
  country

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Movement of w/r in each country

• in capital abundant country, w/r falls to (w/r)1
• in labour abundant country w/r rises to (w/r)1

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Conclusion Stolper-Samuelson Theorem

• The relative returns to factors will equalize
  across countries.
• relative w/r not just w.

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H-O Model - You do

• List at least 3 assumptions of the H-O model

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H-O Model - You do

• This model provides predictions concerning
• trade flows (who will export what)
• returns to factors (which factors benefit from
  trade, which ones lose)
• capital labour ratios used in production
• What are they?

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H-O Model - You do

• Draw an edgeworth box for 2 countries, country 1
  is capital abundant, country 2 is labour
  abundant.
• Choose and initial equilibrium, label it E
• show the movement of factors to trade
• repeat this on the ppf diagram.

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Next class

• Violations of H-O assumptions
• preference reversal
• factor intensity reversal
• monopoly
• monopoly will serve as first step into other
  trade Theories Chapter 10