Download Chapter 4

Week 3
Resources,
Comparative
Advantage,
and Income
Distribution
Slides adapted from Bishop but modified
by Lim
Slides prepared by Thomas Bishop
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Introduction
• In the Ricardian model, trade is explained by
differences in labor productivity that gives rise to
comparative advantage.
• Differences in resources across countries can also
give rise to international trade.
• The Heckscher-Ohlin theory (or factor-proportions
theory) argues that differences in resources (labor,
labor skills, physical capital, land or other factors of
production) across countries create productive
differences that explain why trade occurs.
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4-2
Two Factor Heckscher-Ohlin Model
We discuss the two factor Heckscher-Ohlin model using the
following simplifying assumptions:
1. Labor and land are the resources important for production (two
factors of production = labor and land).
2. The amount of labor services and land varies across countries,
and this variation influences productivity.
3. The supply of labor services and land in each country is constant.
4. Only two goods are important for production and consumption:
cloth and food.
5. Competition allows factors of production to be paid a
“competitive” wage, a function of their productivities and the
price of the good that they produce, and allows factors to be used
in the industry that pays the most.
6. Only two countries are modeled: Home and Foreign.
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4-3
What an economy can produce?
• When there is more than one factor of production, the
opportunity cost in production is no longer constant and
the PPF is no longer a straight line. Why?
• Let’s expand the Ricardian model to include two factors
of production, labor (L) and tanah (T).






aTC = hectares of tanah (land) used to produce one m2 of cloth
aLC = hours of labor used to produce one m2 of cloth
aTF = hectares of tanah (land) used for one calorie of food
aLF = hours of labor used to produce one calorie of food
L = total amount of labor services available for production
T = total amount of tanah (land) available for production
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4-4
• Production possibilities are influenced by both land
and labor (requirements):
aTF QF + aTC QC ≤ T
Tanah required
for each unit of
food production
Total units
of food
production
Tanah required
for each unit of
cloth production
aLF QF + aLC QC ≤ L
Labor required
for each unit of
food production
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Total amount of
tanah resources
Total units
of cloth
production
Total amount of
labor resources
Labor required
for each unit of
cloth production
4-5
• Assume that cloth production is labor intensive and
food production is tanah intensive.
• For instance, Cloth: aLC = 4 hours of labor
aTC = 1 hectare of tanah
Food: aLF = 2 hours of labor
aTF = 2 hectares of tanah
To measure factor intensity, it is not the absolute
amount of labor and tanah used, but their ratio.
Labor intensity (Cloth) = aLC / aTC = 4/1 = 4
Labor intensity (Food) = aLF / aTF = 2/2 = 1
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4-6
Since
aLC / aTC > aLF / aTF
We say that cloth production is labor intensive.
Food production, on the other hand, is:
Tanah intensity (Cloth) = aTC / aLC = 1/4 = 0.25
Tanah intensity (Food) = aTF / aLF = 2/2= 1
Since aTF / aLF > aTC / aLC, we say that food production
is tanah intensive.
• This assumption of factor intensity influences the
slope of the PPF.
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4-7
Fig. 4-1: The PPF Without Factor Substitution
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4-8
Tanah:
When QC = 0,
aTF QF + aTC QC = T
aTF QF = T
When QF = 0,
QF = T/aTF
aTC QC = T
QC = T/aTC
Assume T = 16 hectares of tanah, aTC = 1, aTF = 2,
Then
Slope of PPF
QF = 16/2 = 8
QC = 16/1 = 16
= ΔQF / ΔQC
= (T/aTF) ÷ (T/aTC)
= aTC /aTF
= 1 /2 = 0.5
Slope = Opportunity Cost of Cloth in terms of Food
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3-9
Labor:
When QC = 0,
aLF QF + aLC QC = L
aLF QF = L
When QF = 0,
QF = L/aLF
aLC QC = L
QC = L/aLC
Assume L = 40 hours of labor, aLC = 4, aLF = 2,
Then
Slope of PPF
QF = 40/2 = 20
QC = 40/4 = 10
= ΔQF / ΔQC
= (L/aLF) ÷ (L/aLC)
= aLC /aLF
= 4 /2 = 2
Slope = Opportunity Cost of Cloth in terms of Food
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3-10
Fig. 4-1: The PPF Without Factor Substitution
(Numerical Example)
20
Slope = 2
8
Slope = 0.5
10
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16
4-11
• If tanah could not be substituted for labor or vice
versa, the PPF would be defined by the two resource
constraints.
• The PPF for this economy is the kinked line shown in
blue. Why?
• The economy can’t use more than the available
supply of labor or tanah (in our example, T = 16
hectares of tanah, L = 40 hours of labor).
When QC = 0, how much QF can be produced? 8 or 20
units?
To produce 1 calorie of food, 2 hours of labor (aLF) and 2
hectares of tanah (aTF) is required.
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4-12
How about 8 calories of food? T = 16, L = 16.
✔
How about 20 calories of food? T = 40, L = 40.
✗
When QF = 0, how much QC can be produced? 10 or 16
units?
To produce 1 m2 of cloth, 4 hours of labor (aLC) and 1
hectare of tanah (aTC) is required.
How about 10 m2 of cloth? T = 10, L = 40
✔
How about 16 m2 of cloth? T = 16, L = 64
✗
To reiterate, due to the constraints of L and T, the PPF
is the kinked line shown in blue.
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4-13
• The opportunity cost of producing cloth in terms of
food is not constant.
• The opportunity cost rises as the economy’s mix of
production shifts toward cloth:
 It is low (0.5) when the economy produces less
cloth and more food.
 It is high (2) when the economy produces more
cloth and less food.
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4-14
• The blue kinked PPF line does not allow the
substitution of tanah for labor in production or vice
versa.
 Unit factor requirements are constant along each line
segment of the PPF.
 In our example, Food: 2L, 2T; Cloth: 4L, 1T.
• If producers can substitute one input for another in the
production process, then the PPF becomes curved
(bowed shaped).
 For example, to produce the same amount of cloth, many
workers could work on a small plot of tanah (4L, 1T) or a few
workers could work on a large plot of tanah (2L, 2T).
 Unit factor requirements can vary at every quantity of cloth
and food that could be produced.
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4-15
Fig. 4-2: The PPF with Factor Substitution
Still, the opportunity cost of cloth
in terms of food rises as the
economy produces more cloth
and less food.
Bowed Shaped
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4-16
What an economy does produce?
• The PPF describes what an economy can produce,
but to determine what the economy does produce, we
must determine the prices of goods.
• In general, the economy should produce at the point
that maximizes the value of production, V:
V = PCQC + PFQF
 where PC is the price of cloth and PF is the price of food.
• Define an isovalue line as a line representing a
constant value of production, V.
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4-17
V = PCQC + PFQF
Since the PPF is plotted with QF on the y-axis, and
QC on the x-axis, we will specify the equation of the
isovalue in terms of QF.
PFQF = V – PCQC
QF = V/PF – (PC /PF)QC
The slope of an isovalue line is –(PC /PF), i.e. the
relative price of cloth.
The economy produces at the point that maximizes
V. Q is the point that the PPF touches the highest
possible isovalue line.
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4-18
Fig. 4-3: Prices and Production
At Q, the slope of the PPF equals
– (PC /PF), so the opportunity cost
of cloth equals the relative price of
cloth.
In other words, the trade-off in
production equals the trade-off
according to market prices.
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4-19
What determines inputs combination (tanah
versus labor)? The role of factor prices
• When producers can substitute one input for another
in the production process, then the PPF becomes
bowed shaped (see slide 16).
• In our example, to produce one calorie of food,
farmers use 2L, 2T.
• A two-factor model allows farmers to use different mix
of inputs. For instance, 4L, 1T.
• Figure 4-4 shows different combinations of labor and
tanah in producing one calorie of food.
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4-20
Fig. 4-4: Input Combinations in Food Production
Unit factor
requirements of
tanah and labor are
not constant in the
Heckscher-Ohlin
model
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4-21
• Producers may choose different amounts of factors of
production (labor and tanah) to produce cloth or food.
• Their choice depends on the wage rate (w) for labor,
and the rental rate (r) for tanah.
• As w increases relative to r (w/r ), producers are
willing to use less labor and more tanah (T/L ).
• This implies a positive relationship between wagerental ratio (w/r) and tanah-labor ratio (T/L). See CC
and FF in Figure 4-5.
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4-22
Fig. 4-5: Factor Prices and Input Choices
The graph shows that, at any
given w/r, food uses more
tanah relative to cloth.
This is what we have
assumed
earlierfood
production is tanah-intensive
and cloth production is laborintensive (see slide 6).
Do note that a good cannot
be both tanah- and laborintensive.
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4-23
The relationship between factor prices and
goods prices
• In competitive markets, the price of a good should be
reduced to the cost of production.
• The cost of production, in turn, depends on the factor
prices (w and r).
• We have earlier assumed that cloth is labor-intensive
and food is tanah-intensive.
• An increase in the wages of labor (w) should affect the
price of cloth (PC) more than the price of food (PF).

w
w/r 

PC  > PF  , PC/PF 
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4-24
• An increase in the renting rate of land (r) should affect
the price of food (PF) more than the price of cloth (PC).

r
w/r 

PF  > PC  , PC/PF 
• With competition, changes in w/r are therefore directly
related to changes in PC /PW .
• In fact, there is a positive relationship between w/r and
PC /PF

w/r 
PC/PF 

w/r 
PC/PF 
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4-25
Fig. 4-6: Factor Prices and Goods Prices
The
positive
relationship
between goods prices and
factor prices was clarified in a
classic paper by Stolper and
Samuelson (1941).
Stolper-Samuelson theorem:
if the relative price of a good
increases (say PC), then the
price of the factor used
intensively in the production of
that good increases (in this
case, wage w as cloth is laborintensive), while the price of
the other factor decreases (in
this case, renting rate r).
For details, click this website.
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4-26
Goods Prices, Factor Prices and Input Choices
• It is possible to put Figure 4-5 (see slide 23, factor
prices-input choices) and Figure 4-6 (see slide 26,
goods prices- factor prices) together.
• By putting these 2 diagrams together, Figure 7 shows
the links between goods prices and input choices.
• When good prices = (PC /PF)1, it implies that factor
prices = (w/r)1, and input choices for cloth and food
will be (TC/LC)1 and (TF/LF)1 respectively.
• If the relative price of cloth rises to (PC /PF)2, the factor
prices must rise to (w/r)2. This will cause the input
choices for both cloth and food to rise to (TC/LC)2 and
(TF/LF)2, respectively.
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4-27
Fig. 4-7: From Goods Prices to Input Choices
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4-28
Goods Prices and Income Distribution
• We can also see from Figure 4-7 that when the
relative price of goods changes, it will affect the
distribution of income.
• For instance, an increase in the relative price of cloth,
PC /PF, is predicted to:
  w/r (because cloth is labor-intensive), hence raising the
income of workers (wages w) relative to that of landowners
(rental r).
 T/L  (because producers are willing to use less labor and
more tanah). In this case, the marginal productivity of labor in
both industries , the marginal productivity of tanah in both
industries .
Note: The marginal productivity of a factor typically
decreases when the level of that factor used in
production increases.
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4-29
 In a competitive economy, factors of production (labor and
tanah) are paid their marginal product.
 Real wage = marginal productivity of labor
Real rental = marginal productivity of tanah
 When the marginal productivity of labor in both industries , it
implies that the real income of workers  (hence higher
purchasing power of worker).
 When the marginal productivity of tanah in both industries ,
it implies that the real income of landowners  (hence lower
purchasing power of landowners).
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4-30
How does an economy allocate its resources?
• An economy must fully employ its resources- labor
and tanah.
• The allocation of resources determines the maximum
level of output for cloth and food (on the PPF).
• A convenient way is to use a “box diagram” like
Figure 4-8.
• Width of box = total supply of labor (for cloth & food)
Height of box = total supply of tanah (for cloth & food)
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4-31
Fig. 4-8: The Allocation of Resources
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4-32
How do we determine the intersection point 1?
• To do that, we must know the input choices, that is
the ratio of tanah to labor (T/L).
• Cloth Production: TC/LC determines the slope of OCC.
Food Production: TF/LF determines the slope of OFF.
Note that OFF is steeper than OCC, because food uses
more tanah relative to cloth (food is tanah-intensive, see
slide 23).
Resource Allocation Point: OCC = OFF (Point 1)
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4-33
How do levels of output change when the
economy’s resources change?
• Once we determine the allocation of resources, we
can determine the output levels for cloth and food.
• The next question is how these outputs change when
the economy’s resources change.
• To address this, we will see what happens when the
supply of tanah is increased (the box is taller now).
• Assume that the goods prices are fixed (the slopes
TC/LC and TF/LF remain the same) and the labor
supply are fixed (the box has the same width).
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4-34
Fig. 4-9: An Increase in the Supply of Land
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4-35
• At the new intersection point 2,
Cloth Production: Labor 
Tanah  (Output )
Food Production: Labor 
Tanah  (Output )
• Holding output prices constant, when the supply of
tanah , the output of food that uses tanah intensively
 (and the output of cloth ).
 This biased expansion is called the Rybczynski effect.
 The output of food rises more than proportionately to the
increase in land supply.
 For example, if land supply  by 10%, food output might  by
15 or 20%.
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4-36
Fig. 4-10: Resources and Production Possibilities
To see how an increase in
tanah affects the economy’s
output, we will use the PPF.
When supply of tanah = TT1,
the economy produces at point
1, where the PPF touches the
highest possible isovalue line
with slope –PC/PF (see slides
18-19).
At point 1,
Cloth Production = Q
Food Production = Q
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1
C
1
F
4-37
When supply of tanah , the PPF will
shift out to TT2, indicating that the
economy could produce more food and
cloth.
Since food is tanah-intensive, the
outward shift of PPF is much larger in
the direction of food.
Holding output prices constant (the
slope –PC/PF remains unchanged), the
new production point is at 2.
At point 2,
Food Production  to Q
2
Cloth Production  to Q
F
2
C
Check this conclusion with slide 36!
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4-38
• The biased expansion of PPF is the key to
understanding how differences in resources give
rise to international trade.
 An increase in tanah supply expands PPF disproportionately in
the direction of food production (since food is tanah-intensive)
 An increase in labor supply expands PPF disproportionately in
the direction of cloth production (since cloth is labor-intensive)
• An economy is predicted to be relatively efficient at
producing goods that are intensive in the factors of
production in which the country is relatively well
endowed.
 For instance, an economy with a high ratio of land to labor will
be relatively efficient at producing food.
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4-39
International trade in the Heckscher-Ohlin
model
Further assumptions in H-O model:
• There are 2 countries that engage in international
trade: Home and Foreign.
• Both countries have the same consumer tastes
(hence identical relative demands for food and cloth).
• They have the same technology, with each factor of
production (labor, tanah) yielding the same amount of
output in both countries.
• The only difference between Home and Foreign is in
their resources [Recall that in H-O model,
differences in resources give rise to international
trade].
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4-40
• Further assume
T*/L* > T/L:
 Foreign has an abundant amount of tanah (tanah-abundant)
 Home has an abundant amount of labor services (laborabundant)
• Note that abundance is defined in terms of ratio and
not in absolute quantities (see slide 6).
 Foreign has 80 million workers and 200 million acres of
tanah.
 Home has 20 million workers and 20 million acres of tanah.
 In absolute term, Foreign is abundance in both labor and
tanah.
 In relative term, T/L = 20/20= 1; T*/L* = 200/80 = 2.5
 Foreign is tanah-abundant, Home is labor-abundant
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4-41
• From slide 39, an economy is relatively efficient at
producing goods that are intensive in the factors of
production in which the country is relatively well
endowed.
• Home: Labor-abundant, Cloth: Labor-intensive
Home will be relatively efficient at producing cloth.
• Foreign: Tanah-abundant, Food: Tanah-intensive
Foreign will be relatively efficient at producing food.
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4-42
What happen to
international trade?
relative
prices
with
• The RD curve is downward sloping, reflecting
substitution effects.
• Relative demand of cloth is the quantity of cloth
demanded in all countries (QC + Q*C) relative to the
quantity of food demanded (QF + Q*F) in all countries.
• As the price of cloth relative to the price of food rises
(PC/PF), consumers in all countries will tend to
purchase less cloth and more food, so that the
relative quantity of cloth demanded falls.
• We have assumed earlier that both countries have the
same consumer tastes, hence they have similar RD
curve (see slide 40).
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4-43
• At each relative price (PC/PF), Home will produce a
higher ratio of cloth to food than the foreign country.
 Home will have a higher relative supply of cloth
than the Foreign
 Home RS curve will be to the right of Foreign
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4-44
Fig. 4-11: Trade Leads to a Convergence of Relative Prices
No Trade
Home equilibrium will be at
point 1.
Foreign equilibrium will be at
point 3.
3
2
1
In the absence of trade, PC/PF
is higher in Foreign.
With Trade
PC/PF will converge with a new
world relative price.
The new relative price is
between the two countries’ pretrade prices (say at point 2).
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4-45
How does the convergence of relative prices
translate into a pattern of international trade?
• Like the Ricardian model, the Heckscher-Ohlin model
predicts a convergence of relative prices when
countries engage in international trade (see slide 45).
• With trade, the relative price of cloth is predicted to
rise in the labor-abundant Home (from 1 to 2)
 The rise in the relative price of cloth leads to a rise in the
relative production of cloth and a fall in relative
consumption of cloth
 Home becomes an exporter of cloth and an importer of food.
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4-46
• With trade, the relative price of cloth is predicted to fall
(from 3 to 2), implying that the relative price of food
rises in the tanah-abundant Foreign.
 The rise in the relative price of food leads to a rise in the
relative production of food and a fall in relative consumption
of food
 Foreign becomes an exporter of food and an importer of cloth
• An economy is predicted to export goods whose
production is intensive in factors with which the
economy is abundantly endowed.
 Home: Labor-abundant EXPORT Cloth (Labor-intensive)
 Foreign: Tanah-abundant EXPORT
intensive)
Food
(Tanah-
 This proposition is called the Heckscher-Ohlin theorem
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4-47
How does the convergence of relative prices
affect income distribution?
• International trade leads to convergence of relative
prices ( see slide 45).
• Changes in relative prices will affect the relative
earnings of labor and tanah.
• With trade, the relative price of cloth is predicted to
rise in the labor-abundant Home (see slide 45)
 A rise in the price of cloth raises the purchasing power of
workers (laborers), but lowers the purchasing power of land
owners.
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4-48
• With trade, the relative price of cloth is predicted to
fall, implying that the relative price of food rises in the
tanah-abundant Foreign (see slide 45)
 A rise in the price of food raises the purchasing power of land
owners, but lowers the purchasing power of workers
(laborers)
The model predicts that owners of abundant factors
gain with trade, but owners of scarce factors lose.
Home: Labor Abundant
Laborers Gain
Landowners Lose
Foreign: Tanah Abundant Landowners Gain
Laborers Lose
Unlike Ricardian model, not everyone gains from
trade in H-O model.
4-49
Case Study: Trade and Income Distribution
• Over the last 40 years, income inequality has
increased in the U.S., as wages of unskilled workers
have grown slowly compared to those of skilled
workers.
• At the same time, countries like South Korea, Mexico,
and China have exported to the U.S. goods intensive
in unskilled labor (e.g., clothing, shoes, toys,
assembled goods).
• Many observers attribute the growing income
inequality in U.S. (abundantly endowed with highly
skilled
workers,
and
low-skilled
labor
is
correspondingly scarce) to the growth of trade with
these NIEs.
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4-50
•
The Heckscher-Ohlin model predicts that owners of
abundant factors will gain from trade and owners of
scarce factors will lose from trade.
•
But little evidence supporting this prediction exists.
Here are 3 reasons given for the failure:
1. According to the model, a change in the
distribution of income occurs through changes in
output prices, but there is no evidence of a change
in the prices of skill-intensive goods relative to
prices of unskilled-intensive goods.
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4-51
2. According to the model, if wages of skilled workers
are rising and those of unskilled workers are falling
in the skill-abundant country (like U.S), then the
reverse should be happening in the unskilled labor
abundant countries (i.e. wages of unskilled workers
should increase relative to wages of skilled labor):

But this is not the case for Mexico, a country supposed to
be abundant in unskilled workers.
•
Wages of skilled labor have increased more rapidly in Mexico
than wages of unskilled labor.
3. Trade is a small fraction of the U.S. economy, so its
effects on U.S. prices and wages prices should be
small. In other words, the H-O model can still be
correct.
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4-52
How does the convergence of relative prices
lead to equalization of input (factor) prices?
• Unlike the Ricardian model, the Heckscher-Ohlin
model predicts that input (factor) prices will be
equalized among countries that trade (wages and
rental will be the same in Home and Foreign).
• From Figure 4-6 (see slide 26), given the goods prices
(PC/PF), we can determine w/r.
• With trade, relative goods prices converged in both
countries (see slide 45).
• If Home and Foreign face the same relative prices,
they will also have the same factor prices (due to the
positive relationship).
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4-53
Case Study: Equalization of Factor Prices
• In the real world, factor prices are not equal across
countries (see Table 4-1 for differences in wages).
• Why the H-O model does not give an accurate
prediction? Look at the underlying assumptions.
1. The model assumes that trading countries produce the same
goods (cloth and food), so that prices for those goods will
equalize, but countries may produce different set of goods.
2. The model also assumes that trading countries have the same
technology (see slide 40), but different technologies could
affect the productivities of factors and therefore the
wages/rates paid to these factors.
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Table 4-1: Comparative International Wage Rates
(United States = 100)
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3. The model also ignores trade barriers (e.g., tariffs, import
quotas) and transportation costs, which may prevent output
prices and factor prices from equalizing.
4. The model predicts outcomes for the long run, but after an
economy liberalizes trade, factors of production may not quickly
move to the industries that intensively use abundant factors.
 In the short run, the productivity of factors will be determined
by their use in their current industry, so that their wage/rate
may vary across industries.
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How does international trade expand the
economy’s consumption possibilities?
• International trade makes it possible for the mix of
cloth and food consumed differ from the mix
produced.
• However, a country cannot spend more than it earns.
• Hence, the total value of consumption = total value of
production, i.e.
PCDC + PFDF = PCQC + PFQF
Consumption
of cloth
Consumption
of food
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Example
PC = $2
QC = 950 units
QF = 100 units
PF = $5
DC = 200 units
DF = 400 units
QC > DC =(Production > Consumption, export cloth 750)
QF < DF =(Production < Consumption, import food 300)
Total value of Production = Total Value of Consumption
Check whether you can get 2400!
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• Rearranging the above equation will yield the budget
constraint:
PCDC + PFDF = PCQC + PFQF
PFDF – PFQF = PCQC - PCDC
PF(DF –QF ) = PC(QC – DC)
(DF – QF) = (PC /PF) (QC – DC)
Food
imports
Relative price of
cloth exports
Cloth
exports
This equation is the budget constraint for an
economy, and it has a slope of – (PC /PF)
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Fig. 4-12: The Budget Constraint for a Trading Economy
In the absence of trade,
consumption would be a point
on the PPF (implying the
economy would have to
produce what it consumed)
Point 1 indicates that a country
can always afford to consume
what it produces.
However, with trade, a country
need not consume only the
goods that it produces (not
necessarily a point on PPF).
With trade, the economy can
consume at any point on its
budget constraint line.
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Fig. 4-14: Trade Expands the Consumption Possibilities
No Trade
Economy’s production and
consumption were at the PPF,
say point 2.
With Trade
The economy can consume at
any point on its budget
constraint.
The portion of the budget
constraint in the colored region
consists of feasible post-trade
consumption
choices
with
consumption of both goods
higher than at the pre-trade
point 2.
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• Notice that this result does not depend on the
assumption
that
pre-trade
production
and
consumption was at point 2.
• Except when pre-trade production was at point 1,
there is always a part of the budget constraint that
allows consumption of more of both goods.
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Empirical evidence on the Heckscher-Ohlin
Model
• Tests on the U.S. data
 U.S. is the most capital-abundant country in the world (higher
capital-labor ratios)
 One would expect U.S. would be an exporter of capitalintensive goods and an importer of labor-intensive goods
 However, Leontief found that U.S. exports were less capitalintensive than U.S. imports (Leontief paradox)
 Figure 4.2 illustrates the paradox, where U.S. exports were
produced with a lower capital-labor ratio than U.S. imports
(see line 3).
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Table 4-2: Factor Content of U.S. Exports and Imports
for 1962
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• Tests on global data
 Bowen, Leamer, and Sveikauskas tested the HeckscherOhlin model on data from 27 countries and confirmed the
Leontief paradox on an international level.
• Tests on manufacturing data between low/middle
income countries and high income countries.
 This data lends more support to the theory.
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In Week 3, we learned that the empirical evidence
broadly supports the Ricardian model (i.e., countries will
export goods in which their labor is especially
productive).
However, most international economists regard the
Ricardian model as too limited.
The H-O model is well accepted, as it allows a
simultaneous treatment of trade pattern (see slides 4647) and income distribution (see slides 48-52).
However, the empirical evidence for the H-O model is
less conclusive.
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Summary
1. Substitution of factors used in the production
process is represented by a curved PPF.

When an economy produces a low quantity of a good, the
opportunity cost of producing that good is low and the
marginal productivity of resources used to produce that
good is high.

When an economy produces a high quantity of a good, the
opportunity cost of producing that good is high and the
marginal productivity of resources used to produce that
good is low.
2. When an economy produces the most it can from its
resources, the opportunity cost of producing a good
equals the relative price of that good in markets.
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3. If the relative price of a good increases, then the real
wage or real renting rate of the factor used
intensively in the production of that good is predicted
to increase,

while the real wage and real lending/renting rates of other
factors of production are predicted to decrease.
4. If output prices remain constant as the amount of a
factor of production increases, then the supply of the
good that uses this factor intensively is predicted to
increase, and the supply of other goods is predicted
to decrease.
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5. An economy is predicted to export goods that are
intensive in its abundant factors of production and
import goods that are intensive in its scarce factors
of production.
6. The Heckscher-Ohlin model predicts that relative
output prices and factor prices will equalize, neither
of which occurs in the real world.
7. The model predicts that owners of abundant factors
gain, but owners of scarce factors lose with trade.
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8. A country as a whole is predicted to be better off
with trade (expanded consumption possibilities),
even though owners of scarce factors are predicted
to be worse off without compensation.
9. Empirical support of the Heckscher-Ohlin model is
weak except for cases involving trade between high
income countries and low/middle income countries.
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