Supplementary notes
Chapter 4
Heckscher-Ohlin Model
• Resource endowment as the key to
comparative advantage
• Two factors of production: Labor and Land
• The PPF is no longer a straight line. The
opportunity cost in production increases as
more of a product is produced. Why?
– More than one factor of production
– Possibility of substitution between the factors
Factor Intensity and Factor Abundance
Assumption. Cloth is labor intensive and Food is land intensive.
Assumption. Home is labor abundant, Foreign is land abundant: L/T >
L*/ T*
Assumption. The resource endowment is the only difference in the two
countries. They share the same technology, same preferences, etc.
In the textbook,
– the two factors are LABOR and LAND.
– the two goods are CLOTH and FOOD.
– the two countries are HOME and FOREIGN.
Factor Prices, Input Choices
Factor Prices and Goods Prices
Factor
Prices,
Goods
Prices
and Input
Choices
Relative Prices
before and after trade
Equilibrium
• Production equilibrium
– Occurs where the relative price and the slope
of the PPF (the opportunity cost) are equal
• Consumption equilibrium
– Occurs where the relative price and the slope
of an indifference curve (consumers’ relative
evaluation) are equal
Equilibrium in autarky
• Occurs where the PPF and an indifference
curve are tangent to each other and thus
have the same slope.
• The equilibrium relative price is
determined by the tangent line.
Autarky
The Heckscher-Ohlin Theorem
A country has comparative advantage in the
product which makes intensive use of
productive factors with which it is
abundantly endowed with.
• Home  labor abundant  CA in cloth
which is labor intensive
• Foreign  land abundant  CA in food
which is land intensive
Trade Equilibrium
Home
Foreign
Initial condition
RP of C
Comp Adv.
low
C
high
F
With Trade
RP of C
Production of C
Production of F
rises
increases
decreases
falls
decreases
increases
Trade Equilibrium
The Factor Price Equalization Theorem
• Free trade leads to the
international equalization
of individual factor prices.
• Wages are equalized
across countries even if
there is no international
mobility of labor.
H
F
low
high
high
low
With trade
Wage
rises
Rental
falls
falls
rises
Initial
Wage
Rental
Why factor prices are NOT
equalized internationally?
• List the assumptions of the HO model
• Which of them are crucial for the factor
price equalization theorem?
The Stolper-Samuelson Theorem
• In Home, abundant in labor, wages rise
while rentals fall with trade. This benefits
workers (the abundant factor) and hurts
land owners (the scarce factor).
– The rise in wage is greater than the increase
in the price of cloth. Thus, real income of
workers increases in either good.
– The fall in rental is greater than the fall in the
price of food. Thus, real income of capital
owners declines in either good.
Political Economy of Trade
Who will be more likely to oppose free trade?
a. the owners of scarce factors of production
b. the producers of import-competing products
c. the consumers of export products
Who will be free traders?
a. the owners of abundant factors of production
b. the producers of export products
c. the consumers of import products
Gains from trade
• In the HO model, some gain and some
lose from trade. Does the nation as whole
gain or lose from trade? How to show it?
Trade and Income Distribution
• In the U.S.
– High skill labor – abundant factor
– Low skill labor – scarce factor
• The wage distribution has become more
unequal since the late 70s.
• This is consistent with the StolperSamuelson Theorem. Does it mean that
trade is responsible for the above trend?
The Leontief Paradox
•