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BA 187 – International Trade. Hecksher-Ohlin Model & Relative Factor Endowments. Hecksher-Ohlin Model. Two countries, two goods, X and Y, and two factors of prod’n, labor, L and capital, K. (2 x 2 x 2 model) Technology identical between countries.

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BA 187 – International Trade

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Ba 187 international trade

BA 187 – International Trade

Hecksher-Ohlin Model & Relative Factor Endowments


Hecksher ohlin model

Hecksher-Ohlin Model

  • Two countries, two goods, X and Y, and two factors of prod’n, labor, L and capital, K. (2 x 2 x 2 model)

  • Technology identical between countries.

  • Production functions for both goods exhibit constant returns to scale.

  • Each commodity has a different factor intensity, which are not affected by relative factor prices.

  • Tastes and preferences identical between countries.

  • Perfect competition in both industries and both countries.

  • Factors are perfectly mobile within countries but perfectly immobile between countries.

  • No transportation costs or tariffs or other barriers to trade.


Factor endowments and factor intensities

Factor Endowments and Factor Intensities


Factor intensities factor abundance

Factor Intensities & Factor Abundance

  • Factor Intensities: (A property of production technologies)

    • A Good Y is said to be capital-intensive if the ratio of capital-labor in its production is higher than the ratio of that used to produce Good X, at any relative factor price ratio. i.e. (K/L)Y > (K/L)X .

    • In a two good world, if Good Y is capital-intensive then Good X will be labor-intensive, at any relative factor price ratio.

  • Factor Abundance: (A property of factor endowments)

    • Physical Units definition: A nation is capital-abundant if its capital/labor ratio (K/L) is larger than that of the other nation.

    • Relative Factor Price definition: A nation is capital-abundant if its ratio of wage rate for labor to rental price of capital (w/r) is larger than that of the other nation.

    • We assume these two def’ns are equivalent (although they aren’t).

  • H-O model combines both factor intensities of goods and relative factor abundance of nations to determine trade patterns.


Relative factor endowments

Relative Factor Endowments

Source: Bowen, Leamer, & Sveikauskaus, AER 1987


Factor endowments intensities

[K/L]FY

[K/L]HY

2Y

2Y

[K/L]FX

1Y

1Y

[K/L]HX

2X

2X

1X

1X

Relative Factor Price, (w/r)Home

Relative Factor Price, (w/r)Foreign

Factor Endowments & Intensities

1. Good X is “ labor-intensive” in both nations.

Foreign, K/L high

Capital, K

2. Good Y is “ capital-intensive” in both nations.

[Implies (w/r) high]

Home, K/L low

[Implies (w/r) low]

Capital, K

Labor, L

Labor, L


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Good X

Good Y

Factor Prices and Input Choices

Note from previous slide:

  • As (w/r) increases from Home to Foreign, K/L ratio used to produce Good X increases. The same is true for Good Y.

  • Implies there is an upward-sloping relation between relative factor price w/r and K/L used in production of each good.

  • Also, at any level of (w/r) Good Y always uses higher K/L in prod’n. Thus its relation is below that for Good X.

Wage-rental ratio,

w/r

Capital-Labor Ratio

K/L


Deriving a nation s ppf in the h o model

Deriving a Nation’s PPF in the H-O Model


Allocation of factors to goods prod n

Labor, L

OY

OY

[K/L]HY

2Y

Total Capital

1Y

[K/L]HX

[K/L]HY

[K/L]HY

Capital, K

2X

1X

Total Labor

Allocation of Factors to Goods Prod’n

Capital, K

OX

Labor, L


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Y

2. Implicit in this allocation are prod’n levels of both Y =QY(KY, LY) and X =QX(KX, LX).

PPF

3. Varying w/r picks out different allocations and prod’n points, tracing out PPF.

B

LY

X

B

KX

KY

LX

Allocation of Factors & Nation’s PPF

1. Box below shows allocation of capital and labor to each good, for a given w/r ratio.

Capital, K

OY

[K/L]HX

[K/L]HY

OX

Labor, L


Equilibrium in the hecksher ohlin model

Equilibrium in the Hecksher-Ohlin Model


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Assuming identical utility function for Home & Foreign

Home & Foreign PPF’s differ due to differences in

technology or factor endowments.

QF

AF

Autarky Equilibrium at AH and AF

C*

Opening trade changes relative prices

New equilib. consumption at C*.

Each country has different prod’n ;point.

AH

QH

(PX/PY)*

PPFF

PPFH

Differing Technology/Endowments

Y

X


Hecksher ohlin theorem

Hecksher-Ohlin Theorem

  • Countries will export goods that use their abundant factors intensively and import those goods that use their scarce resources intensively.

    • Previous slide shows how factor endowments determines shape of each nation’s PPF.

    • Assuming identical utilities, then Hecksher-Ohlin theorem result arises for the pattern of trade.

  • Effects of trade:

    • Trade results in mutual gains.

    • Countries reallocate factors to increase specialization in goods that use their abundant factors intensively.

    • Relative commodity prices are equalized across nations after trade. (This will have implications for relative factor prices across nations also.)


Net export of factor services 1967

Net Export (+) of Factor Services - 1967

Source: Bowen, Leamer, & Sveikauskaus, AER 1987


Trade distribution and welfare in the h o model

Trade, Distribution, and Welfare in the H-O Model


Relative product prices factor prices

Relative Product Prices & Factor Prices

  • Relative product price (PX/PY) is linked to relative factor returns (w/r) in the H-O model by the mobility of factors between industries within a country.

  • Assume relative price of X rises in Home from opening trade.

    • Higher (PX/PY) leads Home producers to raise supply of X relative to Y.

    • Good X is labor-intensive so generates larger increase in demand for labor than labor released by fall in supply of capital-intensive Good Y.

    • Result is increase in demand for labor, driving up real wage, w.

    • Exact opposite result for capital in Home as prod’n shifts to Good X.

    • Higher (PX/PY) thus leads to higher (w/r) as a result of different factor intensities of the Goods combined with labor mobility between industries within Home.

  • Diagram on next slide illustrates this relationship between relative product prices and relative factor prices in H-O model.


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Relative Factor Prices and Product Prices

As (PX/PY ) increases suppliers switch production from Good Y to Good X.

Good Y is capital-intensive, while Good X is labor-intensive.

Reducing production of Y increases capital by more than that needed for X. Implies fall in return to capital, r.

This also increases labor by less than that needed for X. Implies rise in return to labor, w.

Rise in (PX/PY ) thus results in rise in (w/r).

Relative Price of X,

PX/ PY

SS

Wage-rental ratio

w/r


From relative prices to production

From Relative Prices to Production

  • In the Hecksher-Ohlin Model:

    • For a given set of factor prices, firms choose specific, but different, ratios of factor inputs (K/L) to produce each Good.

    • A given set of relative product prices (PX/PY) is associated with a given relative factor price (w/r).

  • Combining these two results allows us to examine what capital/labor ratios are used in prod’n of each good in each nation before trade.

    • Provide diagrams linking the two results on next slide.

  • Will also be able to examine the consequences of the equalization of relative product prices as result of trade for the relative factor prices and capital/labor ratios across countries.


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2. Good X is L-intensive,

Good Y is K-intensive

1. Assume Home is Labor-abundant,

Foreign Capital-abundant

Good X

Good Y

(w/r)F

(w/r)H

(PX/ PY)F

(PX/ PY)H

(K/L)XH

(K/L)YH

(K/L)XF

(K/L)YF

Relative Factor Prices and Product Prices

Wage-rental ratio,

w/r

SS

K/L

PX/ PY


Capital labor ratios by industry for u s 1985

Capital/Labor Ratios by Industry(For U.S. 1985)

Source: U.S. Dept. of Commerce, Annual Survey of Manufactures


Trade distribution welfare

Trade, Distribution & Welfare

  • Factor Price Equalization Theorem

    • International trade will bring about the equalization in the relative and absolute returns to homogenous factors of production across nations.

    • Trade in final goods essentially substitutes for movement of factors between countries to equalize differences in relative factor returns.

  • Stolper-Samuelson Theorem

    • Free trade will result in an increase in the reward to the abundant factor and a decrease in the reward to the scarce factor, i.e. the relative return earned by the abundant factor will rise with the opening of trade.

    • Assuming full employment before and after trade.

  • Do not find complete factor price equalization of H-O theory.

    • May be barriers to adjustment: trade barriers, transportation costs, heterogeneous capital or labor, non-traded goods, imperfect competition, unemployed factors, etc.


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Good X

Stolper-

Samuelson

Factor Price

Equalization

Good Y

Relative Factor Prices and Product Prices

Wage-rental ratio,

w/r

SS

K/L

PX/ PY


Convergence of real wages

Convergence of Real Wages

Real Hourly Wage in Manufacturing

(as Percentage of U.S. Wage)

Source: IMF, OECD, and US BLS


Factor growth in the h o model

Factor Growth in the H-O Model


Rybczinski theorem

Rybczinski Theorem

  • At constant product prices, an increase in the endowment of one factor will increase by a greater proportion(magnification effect) the output of the good intensive in that factor, and will reduce the output of the other good.

  • Intuition:

    • Assume that the supply of capital increases.

    • Constant product prices imply constant relative factor returns, (w/r).

    • But relative factor returns can remain constant only if K/L and productivity of K and L remain constant in prod’n of both goods.

    • To fully employ new capital, while keeping K/L constant in both goods, requires fall in output of labor-intensive Good X to release enough labor to absorb increase in K in prod’n of Good Y.

    • Thus output of capital-intensive Good Y increases while output of labor-intensive Good X falls.


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+

L1Y

O1Y

DK

+

L0Y

O0Y

K0X

K0Y

-

+

K1X

K1Y

[K/L]HY

L0X

L1X

-

Factor Growth & the Rybczinski Theorem

Good Y

K0

[K/L]HX

OX

Labor, L

Good X


Changes in relative factor endowments

Changes in Relative Factor Endowments

Source: Mutti & Morici, Changing Patterns of U.S. Economic Activity & Comparative Advantage


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