International Economic Course
Day 2: International
Trade Theory
Presented by:
Anh Duy Nguyen, PhD. International Economics
Duyna@uef.edu.vn
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Main Contents
Main International Trade Theories:
– Benefits and Costs of International Trade
– The Mercantilists’ view on Trade
– Trade based on Absolute Advantage : Adam
Smith
– Trade based on Comparative Advantage: David
Ricardo
– The Heckscher-Ohlin Theory
– Examples
Review Questions:
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Lessons of Trade Theory
1. Free trade can raise aggregate economic efficiency
and aggregate economic welfare.
2. Free trade will benefit a country even if it is less
efficient than all other countries in every industry.
3. Some people will suffer
4.
losses with free trade.
A domestic firm may lose out in international
competition even if it is the lowest cost producer in the
world.
5. Trade protection may be beneficial for a country.
6. Although trade protection can be beneficial, the case for free
trade remains strong.
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What Is International
Economics About?
Goods and services flow across international borders. So
do people. The effects of trade and migration are part of
international economics.
Residents of one country may borrow money from and
lend money to residents of other countries. The effects of
this is also part of international economics.
Government policies of one country may affect other
countries. This too is international economics.
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Concerns of Trade Theory
The classical theory of international trade is
concerned with the following three
questions:
1. What are the gains from trade?
 In other words, if countries benefit from
international trade, where do the gains come
from, and how are they divided among the
trading countries?
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Countries trade to get
something better too…..
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Concerns of Trade Theory
1. What are the gains from trade?
That there are gains from trade is probably the most important insight in
international economics.
Countries selling goods and services to each other almost always
generates mutual benefits.
1. When a buyer and a seller engage in a voluntary
transaction, they are both usually better off.
Norwegian consumers import oranges that they would have a
hard time producing in Norway.
2. How could a country that is the most (least) efficient
producer of everything gain from trade?
Countries use finite resources to produce what they are most
productive at (compared to their other production choices), and
then trade those products for what they want to consume.
Countries can specialize in production, while consuming a great
diversity of goods and services through trade.
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Concerns of Trade Theory
1. What are the gains from trade?
➢
Trade benefits countries by allowing them to export goods made with relatively
abundant resources and import goods made with relatively scarce resources.
➢ When countries specialize, they may be more
efficient due to the larger scale of production.
➢
Countries may also gain by trading current resources for future resources
(international borrowing and lending) and from international migration.
Trade is predicted to benefit countries as a whole in several
ways, but trade may harm particular groups within a country.
– International trade can harm the owners of resources that
are used relatively intensively in industries that compete
with imports.
– Trade may therefore affect the distribution of income
within a country.
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Concerns of Trade Theory
The classical theory of international trade is concerned
with the following three questions:
2. What is the structure/pattern of
trade?
In other words, which
goods/services are exported, and
which are imported?
What are the fundamental laws that
govern international allocation of
resources and the flow of trade?
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Concerns of Trade Theory
2. What is the structure/pattern of trade?
The pattern of trade describes who
sells what to whom.
Differences in climate and resources explain why Brazil exports
coffee and Saudi Arabia exports oil.
But why does Japan export automobiles, while the U.S.
exports aircraft?
Why some countries export certain products can stem from differences
in:
– Labor productivity
– Relative supplies of capital, labor and land and their
use in the production of different goods and services
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
Main exports: labour-intensive manufactures (clothing,
shoes, electronics), seafood, crude oil, rice, coffee, wooden products,
machiner
Main imports: Machinery and equipment, petroleum products,
steel, raw materials for clothing/shoe industry, electronics, plastic,
automotives
Services remain the strongest sector, accounting for about 43% of GDP
(but only 30% of employment)
Major services sectors: trade, finance, real estate, tourism
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Trade patterns for Vietnam
Xuất khẩu FDI của Việt Nam năm 2022 ước tính rơi
vào khoảng 250 tỉ USD, chiếm đến hơn 70% tổng giá
trị xuất khẩu. Trong 250 tỉ này, Samsung đóng góp
khoảng 30%.
Tổng kim ngạch xuất khẩu của toàn ngành dệt may
và giày dép xấp xỉ bằng Samsung. Intel Việt Nam (với
số lượng công nhân khoảng 3.000 người) đóng góp 7%
nữa, tương đương với toàn ngành gỗ - nơi có số nhân
công vào khoảng 400.000 người.
Có thể hiểu đơn giản cơ cấu xuất khẩu công
nghiệp của Việt Nam = dệt may và da giày +
gỗ + Samsung + Intel + khác.
Nhìn vào phương trình này, có thể thấy
được tính bất định của năm 2023, khi mà thị
trường dệt may, giày da và gỗ chủ yếu là
châu Âu và Mỹ.
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
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Trade patterns for Vietnam
Strong outward-oriented (export-dependent) economy with trade
in goods and services accounting for more than 170% of GDP.
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Trade patterns for Vietnam
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Trade patterns for Vietnam
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Trade patterns for Vietnam
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Trade patterns for Vietnam
Thứ nhất, Việt Nam phụ thuộc rất nhiều vào hoạt động xuất nhập khẩu để tăng
trưởng kinh tế. Dự báo năm 2022 Việt Nam có thể đạt kim ngạch xuất nhập khẩu
khoảng 780-800 tỉ đô la Mỹ, chiếm tỷ lệ gấp đôi GDP, thuộc hạng cao nhất thế
giới. Kinh tế mở cửa như thế sẽ được tác động tốt khi kinh tế toàn cầu tăng
trưởng nhanh, nhưng sẽ bị ảnh hưởng tiêu cực khi kinh tế toàn cầu suy giảm như
dự báo cho vài năm sắp tới. Tương tự như Trung Quốc, Việt Nam cần giảm tỷ lệ
xuất nhập khẩu/GDP bằng cách phát triển phần đóng góp của kinh tế nội địa, kể
cả tăng tỷ lệ nội địa hóa hàng xuất khẩu – để sự tăng trưởng được ổn định hơn.
Thứ hai, xuất khẩu của Việt Nam phụ thuộc nhiều vào thị trường Mỹ;
chiếm khoảng 30% tổng kim ngạch xuất khẩu và rất không cân đối –
nhập siêu của Mỹ đối với Việt Nam đã lên tới 100 tỉ đô la Mỹ trong 10
tháng đầu năm 2022 so với 90,8 tỉ đô la Mỹ cho cả năm 2021. Điều này
làm tăng nguy cơ phía Mỹ sẽ tìm cách tăng thuế quan hay các biện pháp
khác để giảm mức nhập siêu quá lớn đối với Việt Nam. Vì vậy, Việt Nam
cần phải có biện pháp tích cực để làm cho quan hệ buôn bán với Mỹ cân
đối hơn cũng như phát triển các thị trường xuất khẩu khác, nhất là châu
Âu.
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Trade patterns for Vietnam
Thứ ba, Việt Nam phụ thuộc vào Trung Quốc trong nhập khẩu (lên tới 110 tỉ
đô la Mỹ năm 2021 hay 33% tổng kim ngạch nhập khẩu) – đặc biệt là
nguyên liệu, thiết bị và phụ tùng cần để chế biến xuất khẩu. Việt Nam đã có
nhập siêu lũy kế rất lớn đối với Trung Quốc. Nếu nguồn cung ứng đầu vào từ
Trung Quốc bị gián đoạn vì bất cứ lý do gì, công nghiệp và xuất khẩu của
Việt Nam bị ảnh hưởng lớn. Vì vậy Việt Nam cũng cần đa dạng hóa nguồn
nhập khẩu.
Cuối cùng, Việt Nam phụ thuộc vào đội thương thuyền nước ngoài. Khoảng
90% khối lượng hàng xuất nhập khẩu của Việt Nam được chuyển tải bằng
đường biển – lên đến 24 triệu tấn năm 2021. Đội thương thuyền của Việt
Nam chỉ chiếm thị phần 7%, còn phần lớn phụ thuộc vào các công ty hàng
hải nước ngoài. Vì thế, Việt Nam bị ảnh hưởng lớn nếu cước phí quốc tế tăng
cao hay không có đủ và kịp thời tàu do nhu cầu trên thế giới tăng mạnh. Việt
Nam cần có kế hoạch xây dựng đội thương thuyền viễn dương của mình, để
đáp ứng ít nhất là 50% nhu cầu vận chuyển hàng hóa xuất nhập khẩu.
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Concerns of Trade Theory
The classical theory of international trade is concerned
with the following three questions:
3. What
are the terms of trade?
In other words, at what prices are the exported and
imported goods exchanged?
•
ToT indicate changes in relative buying power of a country’s
exports;
Refer to a export basket compared to import basket;
If export prices rises relative to import prices the ToT have
improved; i.e. more import can be acquired for each export unit
•
•
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Concerns of Trade Theory
The classical theory of international trade is concerned
with the following three questions:
3. What
are the terms of trade?
Definition: the price of export goods relative to
import goods – relative prices
The terms of trade of a given country are a proxy
for the benefits from trade to that country
Once a country is engaged in trade, any change
in world market prices affects its terms of trade,
its real income and wealth
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Concerns of Trade Theory
3. What
are the terms of trade?
Income Terms of Trade
The income terms of trade reflect the capacity to
import goods – paid for with exports
An increase in the income terms of trade may
simply reflect an increased integration into the
world economy
This measure does not capture the total capacity
to import: capital transfer can also finance
imports
In the long run, there will be a tendency for exports
and imports to equalize – for exports to pay in full
for imports
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Commodity Terms of Trade:
China
11 Apr 2022
Kristoffer J. M. Hansen, Institute for Economic Policy
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Commodity Terms of
Trade: USA
11 Apr 2022
Kristoffer J. M. Hansen, Institute for Economic Policy
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Effects of Government Policies
on Trade (2 of 2)
If a government restricts trade, what are the costs if
foreign governments respond likewise?
Trade policies are often chosen to cater to special
interest groups, rather than to maximize national
welfare.
Governments tend to adopt tariffs, then negotiate
them down in exchange for reduction in trade
barriers of other countries.
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Introduction: Trade Theories
Understanding the Gains from International Trade
Nations (or firms in different nations) trade with each
other because they benefit from it!
We can divide the different trade theories in four categories...
Early Trade Theory: Mercantilists
Classical Trade Theory: Ricardian Model
Modern Trade Theory: Heckscher-Ohlin Model
Alternative Approaches to Trade Theory (new trade theory)
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Introduction: Trade Theories
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Introduction: Trade Theories
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What are the Consequences
(Benefits and Costs) of International Trade?
Benefits of International Trade
Individuals
▪ Consumption of better quality products with lower prices
▪ Consumption of diverse products
Firms
▪ Greater business opportunities
▪ Greater profit
Nation
▪ Fast economic growth
▪ Job creation
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What are the Consequences
(Benefits and Costs) of International Trade?
Costs of International Trade
Individuals
▪ Loss of jobs employed in the less competitive industries
Firms
▪ Face stronger competition and may lose competitive edge
Nation
▪ Greater income disparity
▪ Possibility of environmental degradation in developing countries
▪ Greater vulnerability to foreign shocks
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But there are Costs
• Economic:
– When trade expands (or contracts)
• Some firms lose market share or shut down
• Their workers lose jobs
• Their communities lose customers
– Vulnerability to foreign recession/inflation
• Non-economic
– Dependence on other countries
– Vulnerability to trade disruption
• Crisis induced (earthquake, flood, disease)
• Policy induced (sanctions, tariffs, export bans)
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Introduction: Trade Theories
Reasons countries trade goods with each other include:
❑Differences in the technology used in each country
(i.e., differences in each country’s ability to
manufacture products)
❑Differences in the total amount of resources
(including labor, capital, and land) found in each
country
❑The proximity of countries to each other (i.e.,
how close they are to one another)
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Other sources of Gain from Trade
• Productivity (most productive firms expand and export)
• Returns to scale (small countries can support larger
firms)
• Competition (monopolies in small countries lose
market power)
• Variety (buyers can access more choices)
• Supply chains (firms source parts from cheapest
sources)
• Technology (producers access foreign technologies)
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Introduction: Trade Theories
Core concept
opportunity cost –
the cost of an activity in terms
of a forgone alternative .
Opportunity Cost = What you give up
What you get
productivity –amount of product produced
in a
unit of time
production possibilities frontier –maximum possible
production of two products at different mixes
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Introduction: Trade Theories
Core concept
absolute advantage – the ability of a country to
produce a product using fewer resources than
other countries
comparative advantage – the ability of a country
to produce a product at a lower opportunity cost
than other countries
❑ autarky –economic self-sufficiency; no trade
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Absolute Advantage
Absolute advantage is when someone is the best
at doing something
– America is the best at producing entertainment
– Lance Armstrong is the best cyclist
Are there cases where someone might be
the best at something but it’s better for
them to not do it?
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Comparative Advantage
Yes! If Lance Armstrong is the best cyclist and
the best typist, while Susie Smith is a weak
cyclist and a moderate typist, who should do
which task?
– Comparative advantage is when a person can
produce something at a lower cost than anyone else
– In this scenario, Susie has the comparative advantage
because it cost her less (in giving up a weak
cycling skill) to perform the typing.
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Comparative Advantage
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Comparative Advantage
America has an absolute advantage in
technology
production and answering service calls when
compared to India
– So why does India answer the phones (even with hard to understand
accents for the caller)?
Simple, America has to give up too many technology
producers (a very complex field) to answer phones
– It is better to give away the inferior task, even if it’s not going to be
done to the superior nature it could have been if it results in a
higher quantity of the first option (technology) being produced
Video clip: http://www.youtube.com/watch?v=38hvvAzgXZY
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Việt Nam nhập khẩu gạo:
Chuyện thường tình Kinh tế
TTCT - Chuyện Việt Nam nhập khẩu gạo là một hoạt động kinh
doanh hoàn toàn bình thường trên thị trường tự do, nhất là khi
nông nghiệp nói riêng, và nền kinh tế Việt Nam nói chung, đang
muốn bước lên cao hơn trên chuỗi cung ứng toàn cầu.
Cũng vì thế, không có gì phải ngạc nhiên khi biết Việt Nam dù là nước
xuất khẩu gạo hàng đầu thế giới, vẫn nhập gần 1 triệu tấn gạo trong
năm 2021, mà từ Ấn Độ chiếm hơn 72%. Gạo nhập từ Ấn Độ là loại
giá rẻ, được dùng chủ yếu làm bún, thức ăn chăn nuôi, sản xuất rượu…
Các nơi sản xuất bún hay thức ăn chăn nuôi thấy gạo ở đâu rẻ, chất
lượng đạt mức yêu cầu thì mua và nhà cung ứng cứ thế tìm nguồn hàng
để nhập.
Ở đây phải thấy sự nhanh nhạy của thị trường và thán phục những
người biết dựa vào quy luật cung cầu, dám suy nghĩ để kết nối nơi xa,
không hề cứng nhắc cho là gạo thì cứ phải tìm nguồn bán trong nước.
Ở hướng ngược lại, cũng không thể bắt nông dân hay đại lý phải bán
gạo cho những nơi sản xuất bún hay thức ăn chăn nuôi gia súc. Một khi
giá xuất khẩu cao hơn, mắc gì họ phải bán với giá rẻ hơn cho người
mua trong nước.
Thậm chí Việt Nam nhập gạo chất lượng cao của Thái Lan, Đài Loan,
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Việt Nam nhập khẩu gạo:
Chuyện thường tình Kinh tế
Bán được giá tội gì bán rẻ
Vậy nỗi lo gạo nhập khẩu sẽ làm giá gạo trong nước hay đe dọa an ninh lương thực thì
phải lý giải thế nào? Nỗi lo này ngày xưa đã dẫn đến việc áp đặt hạn ngạch xuất khẩu
gạo cho từng doanh nghiệp, nhưng hạn ngạch lại tạo ra những rào cản không cần thiết,
ép giá nông dân, dẫn tới việc mua bán hạn ngạch rất phi thị trường.
Chúng ta đã bỏ cơ chế hạn ngạch xuất khẩu gạo, giờ không lẽ tính đến phương án quản
lý bằng hạn ngạch nhập khẩu gạo?
Nhưng sự hợp lý này chỉ biện minh được nếu nghị định mới đề ra các biện pháp quản
lý gạo nhập khẩu theo hướng đặt ra tiêu chuẩn thấp nhất mà gạo nhập khẩu phải đạt
được hay các yêu cầu kỹ thuật, vệ sinh, môi trường…
Các chuyên gia nông nghiệp từng kêu gọi tập trung vào giá trị chứ không đua
về số lượng nữa; tức chỉ cần xuất khẩu một tấn gạo giá cao, còn hơn xuất cả
chục tấn giá bèo, nông dân vừa bớt khổ, vừa có thu nhập tốt hơn, nền sản xuất
nông nghiệp mới leo cao được trong chuỗi giá trị.
Thị trường đang đi đúng hướng này; 80% gạo Việt Nam xuất khẩu hiện thuộc
loại chất lượng cao, giá bán cao - vậy không nên lo ngại về con số gần 1 triệu
tấn gạo giá rẻ nhập khẩu.
Reasons for Trade
Absolute Advantage
When a country has the best technology for
producing a good, it has an absolute advantage in the
production of that good.
Comparative Advantage
Absolute advantage is not a good explanation for
trade patterns. Instead, comparative advantage is the
primary explanation for trade among countries.
A country has comparative advantage in producing
those goods that it produces best compared with how
well it produces other goods.
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The pride of economics:
Comparative advantage
Absolute advantage: What a country is better at doing than some other
country.
– Grapes don’t grow in Scotland
– You cannot make Scotch in France
Comparative advantage: What you comparatively better at doing.
– China may be better at everything
– But it cannot sell everything, otherwise the other countries will have
nothing to pay with
– David Ricardo observed that once trade opens up, countries would
specialize in goods where they have comparative advantage
– And the GNP of both countries would therefore go up.
– Another of those central results that almost every one learns in
econ 101 and is an economist’s Pavlovian’s reflex: There must be
gains from Trade!
Introduction: Trade Theories:
Why Trade ?
Adam Smith detailed the
benefits of specialization
and division of labor in his
book The Wealth of Nations.
Each worker could become
an expert in a small area,
greatly increasing efficiency.
•
•
Two reasons for trade (micro and macro)
Smithean: efficiency / economies of scale
Ricardian:comparative advantage
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International Trade Theory: Mercantilism
Mercantilism
– Economic philosophy in 17th and 18th centuries, in England,
Spain, France, Portugal and the Netherlands.
– Belief that nation could become rich and powerful only by
exporting more than it imported.
The Mercantilists’ Views on Trade
– Export surpluses brought inflow of gold
and silver.
– Trade policy was to encourage exports and restrict imports.
– One nation gained only at the expense of another.
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International Trade Theory: Mercantilism
Mercantilism
– Economic philosophy in 17th and 18th centuries, in England,
Spain, France, Portugal and the Netherlands.
Mercantilism is not an organized body of thought.
Schemes, plans, suggestions for policies to increase
national wealth
Especially prominent from the 16th to the 18th century in
Europe
The Montaigne fallacy: in trade, the gain of one person or
country can only come at the loss of another person or country
“No profit can possibly be made but at the expense of
another.”
There is a fixed amount of trade, one country can only
expand its share at the expense of other countries’
Therefore, exports should be encouraged and
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imports discouraged
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International Trade Theory: Mercantilism
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Mercantilism—main themes
The main themes of Mercantilism are as follows:
– The ultimate objective of economic policy is the
political power, both internal and external, of the
state.
– The power gained by one state means power lost by another
state.
Therefore, the interests of nation states are perpetually in conflict.
– A nation’s power is measured by its population and its stock
of precious metals such as the gold and silver that are
embodied in the money in use at the time.
A high population could supply soldiers.
Money (in the government’s treasury) could pay for large
armies and navies.
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Mercantilism—main themes
The main themes of Mercantilism are as follows:
– Population growth and a rich treasury could only come from
prosperous industry and trade.
– This prosperity could be brought about if the economy’s stock
of money (i.e., gold and silver coins) is large.
– Assuming a state does not have gold and silver mines, the only
way it would increase its stock of those metals is if it exports
more than it imports.
– As a result, ensuring a trade surplus for oneself and a trade
deficit for one’s rivals is the primary objective of economic
policy.
– Tariffs and other import restrictions can be effective in reducing
imports.
– Subsidies and regulation can be effective in increasing exports.
THE SIXTEENTH CENTURY
53
International Trade Theory: Mercantilism
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27
International Trade Theory: Mercantilism
Mercantilism suggests that it is in a country’s
best interest to maintain a trade surplus -- to
export more than it imports
Mercantilism advocates government intervention
to achieve a surplus in the balance of trade
It views trade as a zero-sum game - one in
which a gain by one country results in a loss by
another.
Mercantilists measured wealth of a nation by stock of
precious metals it possessed.
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International Trade Theory: Mercantilism
Government intervenes to achieve a surplus in exports
– King, exporters, domestic producers: happy
– Subjects, others people: unhappy because domestic
goods stay expensive and of limited variety
The Economic doctrine:
in which government
intervention of foreign trade is of paramount importance
for ensuring the prosperity and security of the state.
What are the methods to achieve the surplus in
Exports?
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28
Mercantilist Practices
•
To encourage exports:
Export subsidies, encourage manufacturing, subsidize national
shipping (navigation acts)
To discourage imports:
High tariffs on manufactured goods
Colonies for raw materials (and later: captive markets)
Bullion regulations:
– Prohibition of export of bullion, central government monopoly
– Sophisticated mercantilists realized such regulations selfdefeating
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Consequences of Mercantilism
Gain to privileged merchants
Greater government control and direction of the
economy Colonialism
Corruption: merchants used bribes and similar means to
gain subsidies, protection for their specific interests
Inefficient factor allocation leading to overall reduction
in prosperity
Many policies self-defeating: you cannot permanently
increase your exports without eventually having greater
imports
Bullionism self-defeating (price-specie flow mechanism)
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29
29
International Trade Theory: Mercantilism
What is the weak point of Mercantilism ?
Discuss ? Weaken the National Economy in
long-term ? Why?
Mercantilism is still alive and well in 21st century ?
(Germany, Japan 80s, China 2000s…)
– Reading (page. 34): Today neo-mercantilists =
protectionists: some segments of society shielded
short term
– Examples ? Which countries use this practice today ?
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Criticism of Mercantilism Theory
60
30
30
Criticism of Mercantilism Theory
61
The Wealth of Nations
The Theory of Moral Sentiments
(1759)
An Inquiry Into the Nature and
Causes of the Wealth of Nations
(1776)
31
31
The Wealth of Nations
• Scottish enlightenment Wealth of
Nations 1776 Attacked mercantilism
• Part of general advocacy for free markets:
the “system of natural liberty”
• Peace, easy taxes, and a tolerable
administration of justice
• “Free trade” originally meant free trade both
internally and externally – economic freedom
Wealth of Nations
The causes of economic progress and the
creation of wealth was Adam Smith’s main topic
of interest
– David Ricardo, by contrast, focused on how wealth is
shared among different groups in society
According to Smith, the wealth of a nation
derives from the level of the technology in use.
The level of technology and its rate of
improvement depend on the division of labor.
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International Trade Theory:
Adam Smith’s View on Trade
"It is the maxim of every prudent master of a family,
never to attempt to make at home what it will cost him
more to make than to buy.”
(Adam Smith)
Specialization and trade among regions and
countries are based upon the same principle as among
individuals.
1776, Adam Smith, The Wealth of Nations
World’s wealth is not a fixed quantity
International trade
– Increase the general level of productivity within a country
– Increase world output (wealth)
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Free Trade
Smith was in favor of free trade.
He derived his support for free trade among nations by basing it
on the obvious desirability of trade among individuals:
– "It is the maxim of every prudent
master of a family, never to attempt to
make at home what it will cost him
more to make than to buy".
According to Smith, free trade expands the extent of the market
and, thereby, allows greater division of labor
Free trade also increases productivity by allowing countries
to specialize in what they do well.
This is the Law of Absolute Advantage.
– David Ricardo refined this idea into the Law of Comparative
Advantage
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33
International Trade Theory: Absolute Advantage
Adam Smith argued that a country has an absolute advantage in the
production of a product when it is more efficient than any other country
in producing it
According to Smith, countries should specialize in the
production of goods for which they have an absolute
advantage and then trade these goods for the goods
produced by other countries
In 1770s, Adam Smith argued that import restrictions
would reduce the gains from specialization and
make a nation poorer. He used absolute
advantage to explain the benefits of trade.
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The Invisible Hand
• “[E]very individual … generally, indeed, neither intends to
promote the public interest, nor knows how much he is
promoting it. … he intends only his own gain, and he is in
this, as in many other cases, led by an invisible hand to
promote an end which was no part of his intention. …”
• “…Nor is it always the worse for the society that it was no
part of it. By pursuing his own interest he frequently
promotes that of the society more effectually than when he
really intends to promote it. I have never known much good
done by those who affected to trade for the public good. It is
an affectation, indeed, not very common among merchants,
and very few words need be employed in dissuading them
from it …”
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34
The Invisible Hand
Consumer sovereignty and business competition are
the key components of Smith’s argument that the
pursuit of individual self interest leads to an
excellent social outcome
Consumer sovereignty ensures that consumer needs
determine what gets produced
Business competition ensures that prices are driven
down to unit cost
Thus, without any government control, the most
beneficial goods get produced, and at the lowest
possible price
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Absolute Advantage
Absolute advantage the determinant of international trade
Smith compared nations to households: since individuals
find it beneficial to trade, the same should be true of
nations
A few abstractions to simplify:
– Only two countries
– Only two goods
– Only labour input considered, labour hours constitute
the price of products
This makes the principle easier to see, but more goods
would not change. Remember: relative prices the key
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35
Historical Development of Modern Trade Theory
Principle of absolute advantage
– A two-nation, two-product world
– International specialization and trade
One nation - absolute cost advantage in one good
The other nation - absolute cost advantage in the other good
Each nation must have a good that it is
absolutely more efficient in producing than
its trading partner
– Import goods – if absolute cost disadvantage
– Export goods – if absolute cost advantage
71
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or other
International Trade Theory: Absolute Advantage
Definition “absolute advantage”:
The advantage in the production of a product
enjoyed by one country over another when it
uses fewer resources to produce that
product than the other country does.
➢
A country
– Should specialize in production of and export products for
which it has absolute advantage; import other products
– Has absolute advantage when it is more productive
than another country in producing a particular
product
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36
TABLE 2.1
Absolute advantage; each nation is more efficient in producing
one good
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© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or other
Trade Based on Absolute Advantage:
Adam Smith
Wheat (bushels/labor hour)
Cloth (yards/labor hour)
U.S.
6
4
U.K.
1
5
Output per Labor Hour
▪U.S. has absolute advantage over U.K. in wheat.
▪ U.K. has absolute advantage over U.S. in cloth.
▪ Both nations can gain from specialization in
production and trade.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
37
37
Trade Based on Absolute Advantage:
Adam Smith
No Trade
Specialization
Trade
Trade Gain
U.S.
U.K.
U.S.
U.K.
U.S.
U.K.
U.S.
U.K.
Wheat
6
1
12
0
6
5
-
5-1=4
Cloth
4
5
0
10
6
5
6-4=2
-
Assuming each country has 2 unit labor hours
and specialize on the product that has Absolute
Advantage
US Specialize on Wheat then gain 2 additional Cloth
UK Specialize on Cloth then gain 4 additional Wheat
© AD-UEF
International Trade Theory:
Comparative Advantage
U.S.
U.K.
Wheat (bushels/labor hour)
6
1
Cloth (yards/labor hour)
4
2
Output per Labor Hour
U.K. has absolute disadvantage in both goods.
◼ Since U.K. labor is half as productive in cloth but
six times less productive in wheat compared to
U.S., the U.K. has a comparative advantage in
cloth.
◼
◼
U.S. has comparative advantage in wheat.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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Trade Based on Absolute Advantage:
Adam Smith
© AD-UEF
International Trade Theory: Absolute Advantage
Example:
Suppose country A and country B produce wheat, but that A's
climate is more suited to wheat and its labor is more productive.
Country A will therefore produce more wheat per acre than
country B and use less labor in growing it and bringing it to the
market.
Country A thus enjoys an absolute advantage over country B in
the production of wheat.
Example: If US uses 15 hours of labor to produce one unit of
tomatoes and Mexico uses 10 hours to produce the same amount of
tomatoes, Mexico has absolute advantage in the production of
tomatoes.
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39
International Trade Theory:
Trade Based on Absolute Advantage: Adam Smith
Example: Source of Advantage
– Canada is efficient in growing wheat,
inefficient in growing bananas.
– Nicaragua is efficient in growing bananas,
inefficient in growing wheat.
– Canada has absolute advantage in wheat,
Nicaragua has absolute advantage in bananas.
– Mutually beneficial trade can take place if both
countries specialize in their absolute
advantage.
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International Trade Theory:
Adam Smith’s View on Trade
Specialization and trade advantage both
countries.
Adam Smith and other classical
economists advocated policy of
laissez-faire, or minimal government
interference with economic activity.
Free trade would cause world resources
to be utilized most efficiently, maximizing
world welfare.
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40
Role of Government
As one might expect from Smith’s conviction that markets
were extremely efficient, he was in favor of a government
that did not hamper the working of the market.
However, Smith emphasized the fact that the government
should
– maintain law and order,
– ensure the defense of the nation from foreign enemies,
– erect and maintain public works that private citizens would
not build,
– Subsidize education for those who could not afford it, and
– Regulate international trade when free trade endangers ‘infant
industries’ or compromises national security
Historical Development of Modern Trade Theory
82
© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or other
41
41
Absolute Advantage: Numerical
Example
Absolute advantages: The foreign country (home country) has
an absolute advantage in producing food (clothing)
Foreign Country
Home Country
1 unit of food
2 hours
<
2.5 hours
1 unit of clothing
4 hours
>
1 hour
Relative commodity prices in autarky
Individuals trade equal labour values of food for clothing
For example the price of 1 unit of clothing in the home country
is
0.4 units of food that is 1 hour/2.5 hours
Foreign Country
Home Country
price of 1 unit of food
0.5 units of clothing
2.5 units of clothing
price of 1 unit of clothing
2 units of food
0.4 units of food
83
Absolute Advantage: Numerical
Example
After opening up to trade, both countries completely focus
on their absolute advantages
The foreign country´s (home country´s) labor completely
shifts towards producing food (clothing), which has a higher
value when exported abroad. The foreign country (home
country) imports clothing (food) which is cheaper abroad
Assuming that both countries completely specialize in
their absolute advantage the international prices must
be somewhere in the range:
- 0.5 ≤ international price of 1 unit of food ≤ 2.5 and
- 2 ≥ international price of 1 unit of clothing ≥ 0.4.
Both countries gain by trade and specialize according to
their absolute advantages. The other commodity can be
imported at a lower price than before trade
84
Both countries gain by reaching a higher utility than in autarky
42
42
Sample Problems:
Output per Labor Hour
Who has absolute
advantage in cars?
Cars
Computers
United States
12
4
Japan
10
6
– United States
Who has absolute
advantage in
computers?
– Japan
Sample Problems
Cars
Computers
United States
12
4
Japan
10
6
United States’ opportunity cost of
computers:
12
3
----- = ----- = 3 cars
4
1
Japan’s opportunity cost of computers:
10
5
---- = ----- = 5/3rds of a car
6
3
Who has comparative
advantage in computers?
Japan has comparative
advantage in
computers because they
only have to give up
5/3rds of a car versus the
U.S. who has to give up
3 cars to make 1
computer
43
43
Sample Problems
Cars
Computers
United States
12
4
Japan
10
6
United States’ opportunity cost of cars:
4
1
----- = ----- = 1/3rd of a computer
12
3
Japan’s opportunity cost of cars:
6
3
---- = ----- = 3/5th of a computer
10
5
Who has comparative
advantage in cars?
United States has the
comparative
advantage in cars
because they only
have to give up 1/3rd
of a computer
versus 3/5ths that
Japan has to give
up
International Economics
Absolute Advantage
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44
44
International Trade Theory:
Comparative Advantage
Economic Basis for Trade
What are the factors that determine
how countries will specialize in
international trade?
David Ricardo (On the Principles of
Political Economy, 1819), developed
the theory of comparative
advantage...
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Ricardian Model of Trade
Due to David Ricardo (1772-1823)
Assumptions:
Production uses only labor
Technology:
– Constant unit labor requirements
(labor per unit of output)
– Or equivalently, constant labor
productivities
(output per unit of labor)
(“constant” here means “does not vary with
output”)
Lecture 3: Comp. Advantage
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International Trade Theory:
Comparative Advantage
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Why Trade?
Law of Association
(comparative advantage) –
Even if someone is
absolutely more
productive at 2 activities, if
he is
comparatively more productive at 1
activity than another relative to a
David Ricardo
2nd person, he will be better off
specializing and trading than
producing in isolation.
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Trade: Law of Comparative
Advantage
Ricardo’s Law of Comparative Advantage
improved upon the earlier Law of Absolute
Advantage. How?
If A (Advancedland) is more productive than B
(Backwardland) in every productive activity,
would both countries benefit from trade?
The law of absolute advantage has no answer
to this question.
Ricardo's law of comparative advantage showed
that the answer is yes.
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DAVID RICARDO
Historical Development of Modern Trade Theory
Principle of comparative advantage
– Even if a nation has an absolute cost disadvantage in the
production of both goods
The less efficient nation
– Specialize in and export the good in which it is
relatively less inefficient
Where its absolute disadvantage is least
The more efficient nation
– Specialize in and export that good in which it is
relatively more efficient
Where its absolute advantage is greatest
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47
47
Examples of comparative advantages in international
TABLE 2.2 trade
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International Trade Theory:
Comparative Advantage
Definition “comparative advantage”:
The advantage in the production of a product
enjoyed by one country over another when that
product can be produced at lower cost in
terms of other products (Opportunity
Cost) than it could be in the other country.
Country should specialize in the production of those
goods in which it is relatively more productive... even if
it has absolute advantage in all goods it produces
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48
48
Comparative Advantage
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Gains from Trade & Comparative Advantage:
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49
49
Gains from Trade & Comparative
Advantage:
4 step method for solving the comparative
advantage problem
4 steps
1. Set up the table
2. Calculate the opportunity
costs (OC)
3. Circle the lowest OC in the in each activity
4. Determine who has the competitive advantage for the
good/service ( circled OC and the corresponding
person/country)
99
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International Trade Theory:
Comparative Advantage
U.S.
U.K.
Wheat (bushels/labor hour)
6
1
Cloth (yards/labor hour)
4
2
Output per Labor Hour
◼ U.K. has absolute disadvantage in both goods.
◼ Since U.K. labor is half as productive in cloth but six times
less productive in wheat compared to U.S., the U.K. has a
comparative advantage in cloth.
◼ U.S. has comparative advantage in wheat.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
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50
Trade Based on Comparative Advantage:
David Ricardo
U.S.
U.K.
Wheat (bushels/labor hour)
6
1
Cloth (yards/labor hour)
4
2
U.S.
◼
◼
◼
U.K.
Wheat
UK has higher opportunity cost than US
in Wheat production
Cloth
US has higher opportunity cost than UK
in Cloth production
U.K. has absolute disadvantage in both goods.
Since U.K. labor is half as productive in cloth but six
times less productive in wheat compared to U.S., the
U.K. has a comparative advantage in cloth.
U.S. has comparative advantage in wheat.
Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.
Comparative Advantage
Hours needs to make 1 unit
Hours needed to make 1
unit of …
Opportunity Cost of
producing 1 unit of …
Food
Clothes
Food
Clothes
Alex
1
2
1/2
2
Betty
10
10
1
1
• Let’s say that Alex is currently making all of his own
Food and Clothes.
• If so, Betty can offer 1.5 units of Food to Alex in return
for 1 unit of Clothes and Alex will gladly accept.
• This deal will clearly benefit both Alex and Betty even
though Alex is advanced and Betty is backward.
DAVID RICARDO
51
51
Gains from Trade & Comparative Advantage:
Sources of Comparative Advantage
– Countries’ comparative advantage comes from:
Accumulated Physical and Human Capital
Difference in cultures & social institutions
Dynamic comparative advantage – “learning by doing”
which develops industry specific expertise
– “Infant Industry” argument for tariffs & subsidies
Difference in natural resources, topography, climate may
play an initial role – but acquired advantages dominate
differences in initial conditions
Technological change and governmental policies
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Source of Comparative Advantage
China – workforce/technology
Canada – resources
Alberta – oil
India – technology/skilled people
Mexico – greenhouse/climate
New Zealand – sheep
Vietnam ? ? (Rice, Coffee,
Can you think of any other examples?
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52
The Gains from Trade
Each country is able to consume at a point that lies
beyond its ppc, reflecting the greater productivity under
international division of labour
The gains from trade for each country depends on its
terms of trade: the relative price of its exports in terms of its
imports
International trade affects production, as each country
specializes
And it affects consumption, as the price of imported
goods decline, resulting in higher consumption of these
(substitution effect)
It also increases real incomes, so consumers tend to buy
more of each product (income effect)
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Source of Comparative Advantage
106
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53
Review Question Comparative Advantage
1) Trade between two countries can benefit both countries if
A) each country exports that good in which it has a comparative
advantage.
B) each country enjoys superior terms of trade.
C) each country has a more elastic demand for the imported goods.
D) each country has a more elastic supply for the exported goods.
6) The earliest statement of the principle of comparative
advantage is associated with
A) David Hume.
B) David Ricardo.
C) Adam Smith.
D) Eli Heckscher.
107
Review Question Comparative Advantage
7) The Ricardian model attributes the gains from trade
associated with the principle of comparative advantage
result to
A) differences in technology.
B) differences in preferences.
C) differences in labor productivity.
D) differences in resources.
8) The Ricardian model demonstrates that
A) trade between two countries will benefit both countries.
B) trade between two countries may benefit both regardless of which
good each exports.
C) trade between two countries may benefit both if each exports the
product in which it has a comparative advantage.
D) trade between two countries may benefit one but harm the other.
108
54
54
Review Question Comparative Advantage
19) According to Ricardo, a country will have a
comparative advantage in the product in which its
A) labor productivity is relatively low.
B) labor productivity is relatively high.
C) labor mobility is relatively low.
D) labor mobility is relatively high.
109
Historical Development of Modern
Trade Theory
Principle of comparative advantage
– Even if a nation has an absolute cost disadvantage in the
production of both goods
The less efficient nation
– Specialize in and export the good in which it is
relatively less inefficient
Where its absolute disadvantage is least
The more efficient nation
– Specialize in and export that good in which it is
relatively more efficient
Where its absolute advantage is greatest
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55
55
Pattern of Trade and Gains from Trade:
❑ Each country is exporting the good for which it has
the comparative advantage.
o This confirms that the pattern of trade is
determined by comparative advantage.
o This is the first lesson of the Ricardian model.
❑ There are gains from trade for both countries.
o This is the second lesson of the Ricardian
model.
111
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Implications of comparative advantage
Policy of Laissez-faire (law of free market) still holds
Gains need not be equal
Hours of work traded need not be equal but the
advantage still exists
Trade is based on the existence of
relative – not absolute – production
advantages
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56
56
Any Questions?
DAVID RICARDO
International Economics
Comparative Advantage
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57
More examples
115
Comparative Advantage
Hours needs to make 1 unit
Hours needed to make 1
unit of …
Opportunity Cost of
producing 1 unit of …
Food
Clothes
Food
Clothes
Alex
1
2
1/2
2
Betty
10
10
1
1
DAVID RICARDO
• Let’s say that Alex is currently making all of his own
Food and Clothes.
58
58
International Economics
Comparative Advantage
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International Economics
Comparative Advantage
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59
International Economics
Comparative Advantage
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International Trade Theory:
Ricardian Model of Trade
Most important lessons:
Countries have comparative advantage in
producing different goods and hence they can get
mutual benefits from trade
– This is because countries differ from each
other. The more different they are, the
larger the (potential) benefits from trade
Trade makes both countries better off.
3 ways to conceptualize it:
• indirect production
• expanded consumption
• conservation of resources ??
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60
60
International Trade Theory:
Gain from Trade in General
Sources of Gain From Trade:
– Most sources of gain are analogous to how
individuals gain from trade
– Comparative advantage focuses on
Differences in ability to produce goods
– Other sources of gain, not in this model
Differences in tastes
Economies of scale
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Gain from Trade in General
What trade does not do :
– Trade does not help everybody
There are losers from trade
– (We’ll see later in the course who they are)
– Trade does not reduce inequality
At least not necessarily; it could, in some cases
But there are also good reasons why it may increase inequality
– Trade may not cause countries to grow faster (There is debate on that)
– Trade certainly does not fix all problems
Weak or corrupt government
Failure to save
Poor technology
(Look at some developing. It gains from trade, but it is still very
poor.)
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61
Classical Trade Theory Contributions
Adam Smith—Division of Labor
– Industrial societies increase output using same
labor-hours as pre-industrial society
David Ricardo—Comparative Advantage
– Countries with no obvious reason for trade can
specialize in production, and trade for products
they do not produce
Gains From Trade
– A nation can achieve consumption levels
beyond what it could produce by itself
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What are the ultimate determinants of
comparative advantage?
• Ricardo did not bother to answer this question.
• He just assumed that the differences in
comparative advantage depended on
comparative difference in labor productivity
(that is, differences in technology), but he did
not explain the basis for these differences.
Implicit reason in his example was climate...
• It remained to Heckscher and Ohlin to offer
an explanation for comparative advantage.
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2. Why Do We Trade? - 2.2 Modern Trade Theory: Heckscher-Ohlin Model
62
62
What are the ultimate determinants of
comparative advantage?
• It remained to Heckscher and Ohlin to offer an
explanation for comparative advantage.
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2. Why Do We Trade? - 2.2 Modern Trade Theory: Heckscher-Ohlin Model
126
63
63
Heckscher-Ohlin Model
Trade occurs due to differences in
resources.
Countries have different relative
abundance of factors of production.
Production processes use factors of
production with different relative
intensity.
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International Trade Theory:
Heckscher-Ohlin Model
In addition to differences in labor productivity, trade
occurs due to differences in resources across countries.
The Heckscher-Ohlin theory argues that trade
occurs due to differences in labor, labor skills,
physical capital, capital, or other factors of
production across countries.
– Countries have different relative abundance
of
factors of production.
– Production processes use factors of production with
different relative intensity.
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64
64
International Trade Theory:
Heckscher-Ohlin Model
1.
2.
3.
4.
5.
6.
7.
8.
Basic Model Assumptions :
Two countries, two (homogeneous) goods and two
(homogeneous) factors of production
Identical technology, different factor endowments
Constant returns to scale
Different factor intensities in production
Factors perfectly mobile inside each country and
immobile between the countries
(Identical preferences among everyone)
Perfect competition in all markets:
→
(price of labour) w = MPPL*P, (price of capital) r
= MPPK*P
(No transportations costs)
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International Trade Theory:
Heckscher-Ohlin Model
This is a modern development of the Ricardian theory
Introduced by two Swedish economists: Eli Heckscher and
Bertil Ohlin, in the first part of the 20th century
Heckscher was a famous economic historian, Ohlin
economist and politician and later Nobel laureate
Ohlin’s formulation:
“Commodities requiring for their production much of
[abundant factors of production] and little of [scarce factors]
are exported in exchange for goods that call for factors in the
opposite proportions. Thus indirectly, factors in abundant
supply are exported and factors in scanty supply are imported.”
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International Trade Theory:
Heckscher-Ohlin Model
A country exports the product that uses its
relative abundant factor(s) intensively and imports
the product that uses its relatively scarce factor(s)
intensively
A country is relatively labour-abundant if it has a
higher ratio of labour to other factors than does the
rest of the world
A product is relatively labour-intensive if labour
costs are a greater share of its value than they are
of the value of other products
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International Trade Theory:
Heckscher-Ohlin Model
What are the ultimate determinants of comparative
advantage?
A country has comparative advantage in
those commodities that use its abundant
factors intensively.
This is why labor-abundant countries, such as India and
China export footwear, rugs, textiles, and other labor intensive
commodities; and land-abundant countries, such as Argentina,
Australia, and Canada, export meat, wheat, wool, and other landintensive commodities.
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Heckscher-Ohlin (HO) Model
Eli Heckscher and Bertil Ohlin, Swedish
economists
Model based on two concepts:
1. Factor endowments—the quantities of
productive resources possessed by a country
2. Factor intensity—the amount of labor per unit
of capital used in production of a product
Give examples : Industries differ in factor
intensities ?
Relative Factor Availability
Relative factor availability is key
If wheat is land-intensive and the U.S. has a
relatively greater supply of land than the rest of
the world, then it will tend to export wheat
U.S. land supply/U.S. labour supply > rest of
the world’s land supply/rest of the world’s labour
supply
That is, there are more hectares of usable land
per worker in the
U.S. than elsewhere. This is what gives U.S.
wheat production a comparative advantage
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Factor Endowments
Low K/L ratio
High K/L ratio
Capital (K)
Capital (K)
Labour (L)
Labour (L)
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International Trade Theory:
Heckscher-Ohlin Model
Factor Endowments:
Countries differ in their relative factor endowments
Notation: K=capital, L=labour, r = price of capital, w = price of labour
1 is capitalabundant (labour-scarce), country 2 is labour-abundant
(capital-scarce)
Physical definition: (K/L)1 > (K/L)2  country
Price definition: (r/w)1 < (r/w)2  country 1 is capital-abundant, country 2 is
labour-abundant
Given assumptions of perfect competition + identical technology and preferences,
the physical and price definitions are identical
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Heckscher-Ohlin Model: Factor
Endowments:
❑ Factor endowments:
❑
Factor abundance versus factor scarcity: When a country
enjoys a relative abundance of a factor, the factor’s
relative cost is less than in countries where the factor is
relatively scarce
❑
A country’s comparative advantage lies in the
production of goods that use relatively abundant factors
❑ Relative price levels differ among nations because:
❑
Nations have different relative endowments of factor
inputs {labor (skilled or unskilled)}, land, capital.
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Heckscher-Ohlin Model: Factor
Endowments:
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Heckscher-Ohlin Model: Factor
intensity
The nations differ in that one is relatively labor abundant while
the other is relatively capital abundant.
Further, the commodities produced differ in
factor intensity.
– Factor intensity is determined by the ratio
of capital (K) to labor (L) required for the
production of the commodity.
▪
Different commodities require factor inputs with
differing intensities of production.
▪ Wheat is land intensive
▪ Textiles are labor intensive
▪ Aircraft are capital intensive
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Commodity Factor Intensity
Good X is capital-intensive and
good Y labour-intensive if KX/LX
> KY/LY for all relative factor prices (r/w)  the
firm always maximizes profits / minimizes cost by using
relatively more capital in producing X than in producing
Y.
Further, the commodities
produced differ in factor intensity.
Capital
Isoquant for X
– The commodity requiring the greater K/L
ratio per unit of production is defined as
being capital intensive.
❑
❑
Shoes production is labor-intensive;
that is, it requires more labor per
unit of capital to produce shoes than
computers, so that LS /KS > LC /KC.
Computers are capital-intensive:
KComputer / LComputer > KShoe / LShoe
Isoquant for Y
Labour
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Commodity Factor Intensity:
Example US vs Mexico
For example,
the U.S. has more of both
labor and capital than Mexico, but the
quantity of capital advantage in the U.S. over Mexico is
greater than the quantity of labor advantage in the U.S.
over Mexico.
The U.S., therefore, is capital abundant and
Mexico is labor abundant.
"No country is abundant in everything." Discuss.
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Commodity Factor Intensity:
Example US vs Mexico
Letting K measure the quantity of capital and L the
quantity of labor, (K/L)US>(K/L)MEX, or the amount of
capital per laborer in the U.S. exceeds that of Mexico.
(Verify that it is possible for LUS to be greater than LMEX
and (K/L)US>(K/L)MEX ). Now invert the ratios, which
reverses the inequality, so (L/K)US<(L/K)MEX, which says
that Mexico is labor abundant relative to the U.S. If one
country is capital rich (more capital relative to labor)
then the other is labor rich (more labor relative to
capital).
"No country is abundant in everything."
Discuss.
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Commodity Factor Intensity:
Your turn
Determine which is ?
– capital-intensive commodity ?
– labor-intensive commodity ?
Figure 5.1
K
(K/L)Y=4/8=1/2
Y
4
X
(K/L)Y=2/10=1/5
2
8 10
L
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1 Heckscher-Ohlin Model
Labor Intensity of Each Industry The demand for labor relative to capital is
assumed to be higher in shoes than in computers, LS/KS > LC/KC.
These two curves slope down just like regular demand curves, but in this
case, they are relative demand curves for labor (i.e., demand for labor
divided by demand for capital).
FIGUR
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Commodity Factor Intensity
An economy with a high ratio of labor to capital produces
a high output of cloth relative to food.
Suppose that Home is relatively abundant in labor and Foreign in
capital:
L/K > L*/ K*
– Likewise, Home is relatively scarce in capital and Foreign in labor.
Home will be relatively efficient at producing cloth because cloth
is relatively labor intensive.
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International Trade Theory:
Heckscher-Ohlin Model
Heckscher-Ohlin Theorem with
a Single Technique:
• The structure of trade, in general, can be traced back to
differences in factor endowments, technology, and
tastes.
• Since Heckscher-Ohlin theory assumes that technology and tastes
are similar between countries, it attributes the comparative
advantage to differences in factor endowments.
In summary, the capital-abundant country
exports the capital-intensive commodity, and
the labor-abundant country exports the laborintensive commodity.
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International Trade Theory:
Heckscher-Ohlin Theorem:
Country will export the commodity that uses relatively
intensively its relatively abundant factor of production
example: China is labour-abundant and Finland
is capital-abundant i.e. (K/L)H < (K/L)F and (r/w)H >
(r/w)F
→ China exports labour-intensive products (e.g.
clothes) to Finland and imports capitalintensive products (e.g. paper) from Finland
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International Trade Theory:
Heckscher-Ohlin Theorem:
Country will export the commodity that uses relatively
intensively its relatively abundant factor of production
In summary, France, the capital-abundant
country exports Airplane the capital-intensive
Product (i.e import coffee, labor-intensive
commodity) , and Vietnam the labor-abundant
country exports Coffee ,the labor-intensive
commodity.
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Heckscher-Ohlin Model: Factor
Endowments:
❑ Factor
endowments:
The EU is richly endowed with a wide variety of
factors: natural resources, skilled labor, and
physical capital
– Expectation: The EU will export agricultural products
(particularly those requiring skilled labor and physical
capital) and machinery and industrial goods (requiring
physical capital and scientific and engineering skills)
– Result: Major EU exports include grain products made
with small labor and large capital inputs; and
commercial aircraft made with physical capital and
skilled labor
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1 Heckscher-Ohlin Model
Free-Trade Equilibrium
Pattern of Trade
• Home exports computers, the good that uses
intensively the factor of production (capital)
found in abundance at Home.
• Foreign exports shoes, the good that uses
intensively the factor of production (labor)
found in abundance there.
• This important result is called the
Heckscher-Ohlin theorem.
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International Trade Theory:
Heckscher-Ohlin Model
Summary of Model:
Differences in relative endowments of factors of
production → Comparative advantage
Trade leads to
– Expansion of the industry using intensively the abundant
factor of production (Heckscher-Ohlin Theorem)
– Changes in distribution of income (international factor
price equalization, Stolper-Samuelson theorem)
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International Trade Theory:
Heckscher-Ohlin Model
Summary of Model:
The H-O theory is also known as the factorproportions theory or factor-endowment theory.
A nation will export the product that uses its most
abundant factor intensively.
The H-O model explains comparative advantage
in terms of the factor abundance of nations and
the factor intensity of commodities.
Why is the H.O. model called the factor-proportions theory?
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The Stolper-Samuelson
Theorem
Introduce labor and
capital (machines)
•
Some goods require
more labor
•
Other goods require
A labor rich country will
specialize in the laborintensive technology
A capital rich country will
specialize in the capitalintensive technology
And the rich in
rich countries
But because free trade raises
GNP, the workers in rich
countries can be
compensated, as long as
society taxes the winners and
redistributes to the winners
more capital
Freeing trade should help
the poor in poor countries
Does trade lead to faster growth in poor
countries?
We won’t know…
1. Trade liberalization
does not happen to
random countries
2. What else is
happening at the same
time in the country?
3. How do we quantify
trade liberalization?
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Class Performance:
Multiple choice Tests
Which theory suggested that comparative
advantage arises from differences in national
factor endowments?
a) mercantilism
b) absolute advantage
c) Heckscher-ohlin
d) comparative advantage
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Classroom Performance System
In the 2-factor, 2 good Heckscher-Ohlin model,
trade will ________ the owners of a country's
________ factor and will ________ the good
that uses that factor intensively.
A) benefit; abundant; export
B) harm; abundant; import
C) benefit; scarce; export
D) benefit; scarce; import
E) harm; scarce; export
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Classroom Performance System
According to the Heckscher-Ohlin model, the
source of comparative advantage is a country's
A) factor endowments.
B) technology.
C) advertising.
D) human capital.
E) political system.
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Classroom Performance System
If a good is labor intensive it means that the
good is produced
A) using relatively more labor than goods that are not labor
intensive.
B) using labor as the only input.
C) using more labor per unit of output than goods that are
not labor intensive.
D) using labor such that the total cost of labor is greater than
the total cost of capital.
E) using labor such that the cost of labor is more than 50% of
total cost.
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Classroom Performance System
In the 2-factor, 2 good Heckscher-Ohlin model,
the country with a relative abundance of
________ will have a production possibility
frontier that is biased toward production of
the ________ good.
A) labor; labor intensive
B) labor; capital intensive
C) land; labor intensive
D) land; capital intensive
E) capital; land intensive
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Classroom Performance System
If a good is capital intensive it means that the
good is produced
A) using relatively more capital than goods that are not labor
intensive.
B) using capital as the only input.
C) using more capital per unit of output than goods that are
not capital intensive.
D) using capital such that the total cost of capital is greater
than the total cost of labor.
E) using capital such that the cost of capital is more than 50%
of total cost.
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Classroom Performance System
Assume that only two countries, A and B, exist.
Refer to the table above. If good S is capital intensive, then
following the Heckscher-Ohlin Theory
A) country B will export good S.
B) country A will export good S.
C) both countries will export good S.
D) trade will not occur between these two countries.
E) both countries will import good S.
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Classroom Performance System
Assume that only two countries, A and B, exist.
Refer to the table above. If you are told that Country B is very
much richer than Country A, then the correct answer is
A) country B will export good S.
B) country A will export good S.
C) both countries will export good S.
D) trade will not occur between these two countries.
E) both countries will import good S.
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Classroom Performance System
Suppose that there are two factors, capital and land,
and that the United States is relatively land endowed
while the European Union is relatively capitalendowed. According to the Heckscher-Ohlin model
A) European capitalists should support U.S.-European free
trade.
B) European landowners should support U.S.-European free
trade.
C) all capitalists in both countries should support free trade.
D) all landowners should support free trade.
E) the U.S. should compensate European countries once
trade commences.
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