Download Chapter 4 The Heckscher

Chapter 4
The HeckscherOhlin Model
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Topics to be Covered
• Heckscher-Ohlin model and assumptions
• Factor endowment
• Factor intensity
• Trade equilibrium in the HO model
• Rybczynski Theorem
• Factor Price Equalization Theorem
• Stolper-Samuelson Theorem
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INTRODUCTION
• What determines a country’s comparative
advantage?
• How does international trade affect the size of
an economy’s various industries?
• How does international trade affect the
payments or returns to the factors of
production?
• How does international trade affect the
distribution of income within a country?
• To make sound business decisions it is
necessary to understand what causes
comparative advantage and how it can change
over time
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Heckscher-Ohlin (HO) Model
•
When there is more than one production, the
opportunity cost in production is no longer
constant and the PPF is no longer a straight line.
•
Let’s expand the previous chapter’s model to
include two factors of production, labor services
and capital.
Eli Heckscher and Bertil Ohlin, Swedish
economists
Model based on two concepts:
•
•
1.
2.
Factor endowments—the quantities of productive
resources possessed by a country
Factor intensity—the amount of labor per unit of capital
used in production of a product
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Assumptions of HO Model
• Keep first 10 assumptions (in chapters 2
and 3)
• Drop assumption 11 (labor is only resource)
and 12 (constant returns to scale)
• Add five new assumptions
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Five New Assumptions
• Assumption 13—Two resources, labor (L)
and capital (K), and resource payments,
wages for labor (W) and rent for capital (R)
• Assumption 14—Identical technology in
both countries; choice of production
technique depends on factor prices
(Note: this assumption rules out the
classical basis for trade)
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New Assumptions (cont.)
• Assumption 15—Production of good T is more
labor-intensive than that of good S. Production
of both goods in both countries is subject to
constant returns to scale.
• Labor (capital)-intensive—a good is labor
(capital)-intensive relative to another if its
production requires more (less) labor per
machine than the other good requires in its
production.
• Mathematically, assumption 15 requires:
LT / K T  LS / K S
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New Assumptions (cont.)
• Assumption 16—Country A is relatively
capital-abundant while B is relatively laborabundant.
• Two definitions of resource abundance:
– Quantity definition
– Price definition
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Capital Abundance
• Country A is relatively capital-abundant if:
K A / LA  K B / LB
(Quantity definition)
RA / WA  RB / WB
(Price definition)
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or
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Production Possibility Frontier
• Since the two goods differ in factor intensity
in both countries, the PPFs of each country
will exhibit increasing opportunity cost (i.e.,
PPF will have a bowed out, nonlinear
shape). International trade does not cause
complete specialization
• Because country B is labor-abundant and
good T is labor-intensive, B’s PPF will lie
primarily along (or biased toward) the Taxis (see Figure 4.1).
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FIGURE 4.1 Country B’s Production
Possibility Frontier
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Assumption 17
• Tastes in the two countries are identical.
That is, both countries have the same set of
community indifference curves (CIC).
• This assumption guarantees that a country’s
comparative advantage is determined
primarily by supply, not demand, factors.
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Heckscher-Ohlin Theorem
• A country will have comparative advantage
in, and therefore will export, that good
whose production is relatively intensive in
the factor with which the country is
relatively well-endowed.
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Graphical Proof of HO
Theorem
• Given different PPFs for the two countries
and identical CICs, find autarky equilibrium
points for both countries (see Figure 4.2)
• At the equilibrium point, the slope of each
country’s PPF equals the pre-trade price
ratio
• Since (PS /PT )A < (PS /PT )B , then A(B) has
comparative advantage in, and will export,
good S(T)
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FIGURE 4.2 Proof of the HO
Theorem
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Effect of Rising World Price of
Good S on Country A’s Trade
• Refer to Figure 4.3 below
• Once trade begins, the price of S will rise (as
represented by the three terms of trade or price lines)
• As the price rises from (PS/PT)0 to (PS/PT)1 , A’s
production point moves from X0 to X1.
• With trade, A’s new consumption point is now C1.
• A’s trade triangle is V1C1X1 where V1X1 represents A’s
exports and V1C1 is A’s desired imports.
• The terms of trade that will prevail once trade begins
are determined by reciprocal demand.
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FIGURE 4.3 The Effect of Rising World
Prices of Good on Country A’s Trade
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Trade Equilibrium in HO
Model
• Refer to Figure 4.4
• Terms of trade are determined by reciprocal
demand and lie between the two countries’
pre-trade price ratios
• Equilibrium production with trade exhibits
incomplete specialization (due to increasing
opportunity cost)
• Equilibrium consumption with trade implies
a rise in standard of living
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Trade Equilibrium in HO Model
• Trade triangles are congruent. This forces
seek a price that can prevail in both
countries so desired trade flows are
balanced. If desired trade flows are not
balanced, then, by definition, one country
wants to trade more than the other, and this
will cause the term of trade change.
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FIGURE 4.4 Trade Equilibrium in
the HO Model
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Differences between Classical
and HO Models
• Complete specialization results in classical model,
while incomplete specialization occurs in HO
model.
• In classical model, only demand conditions affect
reciprocal demand. In HO model, reciprocal
demand leads to equilibrium price via changes in
both demand and supply.
• Autarky price in the classical model is determined
only by supply conditions. In HO model, demand
and supply determine autarky price.
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Reciprocal Demand in the Classical
and HO Models
• Refer to Figure 4.5 the major difference between
the tow diagrams is the,
• The national supply curves differ in the two models.
In the classical model, the national supply curve is
horizontal (due to constant cost) up to the point of
complete specialization, at which the curve becomes
vertical. In the HO model, the curve is initially
upward-sloping (due to increasing costs).
• Autarky equilibrium is achieved where the national
demand and national supply curves intersect. Since
the relative price PS/PT is lower in country A, then A
has a comparative advantage in good S.
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FIGURE 4.5 Reciprocal Demand in
the Classical and HO Models
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Reciprocal Demand (Classical)
• See Figures 4.5a and 4.5b.
• When trade begins at a world price p0, A’s
production of S rises to its complete
specialization level and A exports what it
does not consume. In country B, production
of S falls to zero and its imports of S
increase.
• Due to excess demand at p0, the world price
will rise and consumption in both countries
will fall until the world markets attain
equilibrium at new world price p1.
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Reciprocal Demand (HO Model)
• See Figures 4.5c and 4.5d
• Similar to the Classical model except in how
the excess demand is eliminated. As the
world price rises in response to the excess
demand, consumption falls in both countries
but supply also rises in both countries.
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The Importance of Assuming
Identical Tastes in the HO Model
• See Figure 4.6
• Initially, country A has a comparative advantage in
good S due to lower autarky relative price and a
lower supply curve (indicating natural comparative
advantage).
• Suppose that national tastes are different in that A’s
citizens strongly prefer good S while B’s citizens do
not.
• As a result, A’s demand curve shifts upward while
B’s demand shifts to the left.
• Relative prices change such that B now has the
comparative advantage in good S.
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FIGURE 4.6 The Importance of
Assuming Identical Tastes
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Extensions of the HO
Theorem
• Rybczynski Theorem
• Factor Price Equalization Theorem
• Stolper-Samuelson Theorem
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T.M Rybczynski Theorem
1955
• H-O mode offer several other important
theories about economic behavior engaged
in I trade, such as the effect of economic
growth on trade and the impact that trade
has on the distribution of income in the
society.
• At constant world prices, if a country
experiences an increase in the supply of one
factor, it will produce more of the product
intensive in that factor and less of the other
product.
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FIGURE 4.7 The Effect of an
Increase in A’s Capital Stock
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• The theory basically says that the on which
a country grows has an impact on the
production and trade mixes of that country.
• Countries with low saving rates that invest
little in new plant & equipment will tend to
produce & trade goods with high labor
content.
• Countries with high saving & investment
rates will tend to produce & trade more
capital-intensive goods.
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Factor Price Equalization
• Unlike the Ricardian model, the Heckscher-Ohlin model
predicts that input (factor) prices will be equalized among
countries that trade.
• Because relative output prices are equalized and because of
the direct relationship between output prices and factor prices,
factor prices are also equalized.
• Trade increases the demand of goods produced by abundant
factors, indirectly increasing the demand of the abundant
factors themselves, raising the prices of the abundant factors
across countries.
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Factor Price Equalization (cont.)
• But factor prices are not really equal across countries.
• The model assumes that trading countries produce the same
goods, so that prices for those goods will equalize, but
countries may produce different goods.
• The model also assumes that trading countries have the same
technology, but different technologies could affect the
productivities of factors and therefore the wages/rates paid to
these factors.
• Factor equalization in HO model hold perfectly when tow main
assumption exist, that is, no barriers to trade and identical
technology.
• Dan Ben David in 1993 has examined the effects of trade
liberalization has affected income levels in different countries.
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Factor Price Equalization
Theorem
• Given all the assumptions of the HO model,
free international trade will lead to the
international equalization of individual factor
prices.
• Country A is relatively capital-abundant and
rent is low. With trade, the increase in
demand for capital for producing exports
raises rent. The opposite happens in country
B.
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Stolper-Samuelson Theorem
• Free international trade benefits the
abundant factor and harms the scarce
factor.
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Implications of StolperSamuelson Theorem
• Some groups in society will oppose
international trade.
• Scarce factors will lobby government for
trade protection.
• Even though some in society lose, the
country overall benefits from international
trade relative to autarky.
• A system of taxation and transfers could
be developed to compensate the losers
while leaving the gainers better off relative
to autarky.
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