HW4 Solution Key
UCDavis, 160a, Winter 2008
Prof. Farshid Mojaver
Questions on the Heckscher-Ohlin Model
Jeopardy Answers
1.
term used to describe Argentina if Argentina has more land per unit of capital than Brazil.
Land abundant country
2.
term used to describe aluminum production when aluminum production requires more energy per unit of
capital than steel production.
Aluminum is an energy intensive industry
3.
general term used to describe the amount of a factor needed to produce one unit of a good.
Unit Factor Requirement
4.
the two key terms used in the Heckscher-Ohlin model; one to compare industries, the other to compare
countries.
Labor (capital) intensive industry; labor (capital) abundant country
5. term used to describe when the capital-labor ratio in an industry varies with
changes in market wages and rents
Variable factor proportions
6.
term describing the ratio of the unit-capital requirement and the unit-labor requirement in production of a
good.
Capital intensity
7.
8.
the assumption in the Heckscher-Ohlin model about unemployment of capital and labor.
interpretation given for the slope of the production possibility frontier.
Zero
Opportunity cost of production (Y in terms of X)
9.
the H-O model theorem that would be applied to identify the effects of a tariff on the prices of goods and
factors. Stolper-Samuelson Theorem
I. MC Question: 1.D, 2.B, 3.D, 4.C, 5.C, 6.B, 7.B
II. False, True, Or Uncertain, Explain Why (Questions in Heckscher-Ohlin Theory)
Question1
“Opening up free trade does hurt people in import-competing industries in the short run. But in the long
run, when people and resources can move between industries, everybody ends up gaining from free trade.”
False – Opening up free trade is likely to hurt some people. Owner of specialized factors
in import-competing industries and owners of factors used intensively in importcompeting industries will lose from free trade both in the short and in the long run.
Question2
“American workers gain from free trade with China because free trade lowers prices of clothing in the
United States and American workers spent very large portion of their income on clothing”
False – Free trade lowers clothing prices in the United States but it lowers real wage of
American worker too. Since wage income is the main source of American workers we
may conclude that their income goes down with opening up trade with China.
III. Essay Type Questions
Problem 1
How could international trade improve the standard of living in developing countries that are relatively
labor abundant? Use Heckscher-Ohlin theory to answer this question.
Ans) According to the Heckscher-Ohlin Theorem: “A country will export goods that use
its relatively abundant factor more intensely in production, when that country opens up to
trade” (paraphrased). Developing countries can produce more labor-intensive goods, like
clothing, and export them for a higher price than would be paid in autarky.
That is, W actually increases more than either PC or PF so that real wages with respect to
all goods increases. Therefore, the standard of living improves for developing countries
with the opening up of trade, according to the Heckscher-Ohlin model.
Note: One could have used the Stolper-Samuelson
If ∆PF/PF < ∆PC/PC then ∆W/W > ∆PC/PC > ∆PF/PF > ∆R/P
Problem 2
Consider the following information on the factor endowments of two countries:
Factor Endowments
Labor Force
Capital Stock
United States
30 million workers
200,000 machines
Austria
15 million workers
400,000 machines
a. Which country is relatively capital abundant?
b. Which country is relatively labor abundant?
c. Assuming that steel is capital intensive relative to textiles, which country will have a comparative
advantage in the production of steel? Explain why.
Ans)
a. The capital to labor ratios are U.S.: 200,000/30,000,000 = 2/300
Austria: 400,000/15,000,000 = 4/150 = 8/300
Since 8/300 > 2/300, Austria is relatively capital abundant.
b. The labor to capital ratios are U.S.: 30,000,000/200,000 = 150
Austria: 15,000,000/400,000 = 150/4
Since 150 > 150/4, U.S. is relatively labor abundant.
c. Austria has the comparative advantage in the production of steel, according to the
Heckscher-Ohlin Theorem, “Because steel uses Austria’s relatively abundant factor
(capital) more intensely in its production than do textiles. Therefore, Austria should
produce and export steel (although it may still produce some textiles as well, according to
H-O theory).
Problem 3
Explain why/whether each of the following conditions might prevent factor prices from being equalized
across countries in a Heckscher-Ohlin world.
a. One country subsidizes the production of one of its goods
Ans) Say production of good X is subsidizes at a rare s. This increases the price
producers receive for their product to PX (1+ s). Therefore the domestic price ratio at the
point of production will exceed that of international price ratio [PX (1 +s)/PY] domestic >
[PX/PY] world. This will increase the return to factors used intensively in production of X
relative to that of Y.
b. One country imposes environmental regulations that reduce the productivity of capital
in the country's capital intensive sector.
Ans) Then imposition of an environmental regulation that reduces the productivity of K
in the capital intensive sector Y reduces return to K thereby reducing return to K relative
to L.
c. One country has a smaller labor force.
Ans) Lower Labor force has no effect on TFP.
Problem
4
Imagine a two good H-O economy which imports automobiles and exports wheat. Suppose the
production of these two goods use only capital and labor. If the government raises a tariff on the
import of automobiles it will raise the domestic price of autos. Suppose the price of wheat
remains constant. Explain as a result of this tariff who in the economy will gain and who will lose
in real terms?
Ans) With an increase in price of Auto relative demand shifts in favor of Auto production
and hence relative demand for Capital goes up (relative demand for labor goes down).
This will lead to a decrease in L-K ratio employed in the two sectors which lowers real
Wage rates and increases real rentals.
Tariff on Auto imports  PA↑ >0 and so does the cost of production. Since Auto is
capital intensive  domestic QA ↑ demand for K↑ R↑ and R/PA↑ & R/PW↑
Similarly can show PA↑=> L/K↓ =>MPL↓ W↓ and W/PA↓ & W/PW↓
Rent earners win and Wage earners lose
Problem 5
Using a HO framework discuss the effects of U.S.-China trade on Skilled-Unskilled wage gap in
US and China. Do we actually see these predicted effects on skilled-unskilled wage gaps in the
two countries? Are you satisfied with this HO explanation of rising skilled-unskilled wage gap in
US?
Ans) HO would predict that as result of trade between skilled scarce China and skilled
abundant US, price of skilled intensive products increase in US (decrease in China)
according to SS this should lead to an increase in wages of skilled labor (a reduction of
wages of unskilled labor). We expect the opposite to happen in China. That is as result of
US-China trade we expect skilled-unskilled wage gaps to increase in US and to decrease
in China.
We observe the increase in skilled-unskilled wage gaps in US but we do not see the wage
gap reductions we expected to see in China. If anything this has actually increased in
China. HO explanation is not quite satisfactory because, first we are see conflicting effects,
second US trade with NIC’s constitutes only a small fraction of total U.S spending; this is too
small to explain the increased gap.