1 / 35

Dr. Bill W. S. Hung

HKBU-ECON3110 International Economics Lecture Overheads (#02). Heckscher-Ohlin Trade Theory. Dr. Bill W. S. Hung. Neoclassical Trade Theory: The Heckscher-Ohlin Theorem. Basic Assumptions:. 1. Two countries, two goods, two factors -- 2x2x2 mode.

adrina
Download Presentation

Dr. Bill W. S. Hung

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. HKBU-ECON3110 International Economics Lecture Overheads (#02) Heckscher-Ohlin Trade Theory Dr. Bill W. S. Hung

  2. Neoclassical Trade Theory: The Heckscher-Ohlin Theorem Basic Assumptions: 1. Two countries, two goods, two factors -- 2x2x2 mode 2. Identical technological in two countries Production functions are same in two countries 3. Constant returns to scale The sharp of PPC is unchanged 4. Two different factor abundance countries: Labor-abundant and capital-abundant And Two factor intensities commodities: Labor-intensive and Capital-intensive

  3. 5. Identical preference and tastes Two countries are facing the same utility functions 6. Perfect competition Goods market and factors market 7. Factors are perfectly mobile only within a country Factors are restricted to move across countries 8. No transportation costs 9. No restriction on trade 10. Increasing opportunity costs: The PPF curve is concave but not a straight line.

  4. L L < ( ) ( ) or 1 2 K K Factor Price definition: w: labor wage r: rental rate of capital OR The greater the relative abundance of a factor, the lower its relative price. Suppose: Country1 is relative abundance of capital Country2 is relative abundance of labor Factor abundance: Definition: Since Country 1 has relative abundance of capital, thus its rental rate of capital is relatively lower than its wage.

  5. r r ( ) > ( ) w c w Definition: S w w ( ) < ( ) r c r S K K > OR ( ) ( ) S C L L Similarly in terms of factor prices: OR Relative Factor Intensity: Commodity S (steel) is a capital-intensive goods. Commodity C( clothes) is a labor-intensive goods.

  6. The Edgeworth Box: L 0s K C5 C4 C3 C2 C1 S5 S1 S2 S3 S4 K 0c L Contract curve: production efficiency locus (Increasing opportunity cost)

  7. Country I: Capital abundant country Steel S0 S1 steel K2 C3 PPFI C2 S2 S3 C1 C0 Clothes L2 o clothes

  8. Steel S0 S1 steel C3 KI C2 PPF1I S2 C1 S3 C0 Clothes LI o clothes Country II: Labor-abundant country

  9. Y- Steel The shape or pattern of CICs represent the aggregate consumers’ taste or preference E CI0 PX PY (autarky price) PPF 0 X -Clothes Marginal rate of transformation (MRT) Marginal rate Of substitution (MRS) Autarky Equilibrium

  10. Combining two countries input space, output space and consumer preference: S KL LK or I I PI PPFI KL LK I* or II II II CI0 K PII PPFII 0 C L

  11. Increasing opportunity cost  incomplete specialization Different demand condition  different autarky price ratio The different prices in autarky indicates that there is a basis for gainful trade between two countries.

  12. S C CI1 A CI0 PI P PW 0 C Only when PW > PI, Country-I has incentive to reallocate the production from point A to point P and to trade with other country (world), and through exchange (import) to consume at point C. Trade direction, incomplete specialization, and consumption

  13. Labor abundant country Exports (i.e., China) Labor-intensive products Imports Capital-intensive products Capital abundant country Exports (i.e., U.S.A.) Capital-intensive goods Imports Labor-intensive goods The 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 that country is relatively well endowed.

  14. (A)Trade between two countries with Identical Demand & Different Production Structures: Good Y-Steel (PX/PY)1 C0 C1 y3 e’ I’s exports (Y) e1 CII’, cI’ y4,y2 II’s imports (Y) EII (PX/PY)2 y1 E’ (PX/PY)3 PPFI PPFII 0 Good X-Clothes x3 x2,x4 x1 II’s exports (X) I’s imports (X) Country I: capital abundant Country II: labor abundant Good X-clothes: labor-intensive Good Y-steel: capital-intensive The H -O Model

  15. The H-O Model: alternative case: (different consumption level) Good Y-Steel (PX/PY)1 e’ I I’s exports e C’I I’s imports C4 C’II C3 C2 C1 II’s imports E (PX/PY)II II’s exports E’ (PX/PY)3 PPFI PPFII 0 Good X-Clothes II Country I: capital abundant Country II: labor abundant Good X: labor-intensive Good Y: capital-intensive

  16. Good Y-Steel C’ y2 (PX/PY)1 PPFI S2 I’s imports (Y) y1 E1 S1 y3 EI’, eI’ II’s exports (Y) y4 c’ e y5 W2 (PX/PY)3 PPFII W1 (PX/PY)2 x1 x2 x3 x5 0 Good X-Cloth x4 I’s exports (X) II’s imports (X) (B)Trade between two countries with Identical PPFs & Different Demand Conditions:

  17. Y-Steel Community Indifferent utility curves A E CI2 CI1 B CI0 PPFI,II PX PY 0 X -Clothes (autarky price) (C)No Trade between two countries with Identical PPFs & identical Demand Conditions: No Incentive to trade Why?

  18. Gains From Trade Good Y C I1 A I0 P PW 0 Good X Good Y P* A* C* I1* I0* PW 0 Good X 3 important assumptions:  1. No costs of factor mobility 2. Full employment of factors 3. No redistribution of income once trade open (the different curves can show welfare changes)

  19. Good Y E  C: consumption gains (or gains from exchange) C’ C E  E’ and C C’:production gains (or gains from specialization) CI3 CI2 E CI1 Autarky price PX PY E’ PX PY PX PY ( )’ ( )’ PX PY World trade price ( )’ 0 Good X Gains from trade and specialization

  20. Concept Check: Can you show that the production at less than complete specialization leads to a lower level of welfare than at complete specialization.

  21. (K/L)M (K/L)X The Leontief Paradox Leontief statistic is defined as Leontief’s result were startling. He found that the hypothesized reduction of US export would release $2.25 Million worth of capital And 182.3 year of labor-time, for a (K/X)x of approximately $14,000 Per labor-year. On the import side, to produce the foregone import would require $3.09 million worth of capital and 170,0 years of Labor-time, yielding a (K/L)M of approximately $18,200 per labor-year. Thus, the Leontief statistic for the US was 1.3 (= $18,200/$14,000), Unexpected for a relatively capital-abundant country. What are the implications of the Leontief Paradox?

  22. Invalid assumptions to Heckscher-Ohlin Model 1. Demand reversal 2. Factor-intensity reversal 3. Transportation costs 4. Imperfect competition 5. Immobile or commodity-specific factors 6. US tariff structure 7. Different skill levels of labor others 8. The role of natural resources 9. Income inequality

  23. 1. The Factor Price Equalization Theorem: Given all the assumptions of the H-O model, free trade will lead to the international equalization of individual factor prices.(The impact of trade on factor prices) 2. The Stolper-Samuelson Theorem: Free trade benefits the abundant factor and harms the scarce factor.(The impact of trade on income distribution) 3. The Rybczynski Theorem: 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 loss of the other.(The effect of economic growth on trade)

  24. Factor price equalization theorem When home and foreign country trade with each other, the relative prices of goods converge. This convergence, in turn, causes convergence of the relative prices of factors. Before trade: (w/r)II > (w/r)world > (w/r)I(Country-I wage is lower) After trade: (w/r)I = world factor price = (w/r)II because the goods prices are equalized in two countries Example: When trade open between China and Hong Kong, Wages increase in China, Wage decline in Hong Kong

  25. After trade adjustment in Country II (labor-abundant) case: Producer adjusts output due to relative factor prices changes. (K/L)s1 K K (w/r)1 (K/L)S0 IS0 IC1 IS1 IC0 (K/L)c1 (w/r)0 ( K/L)c0 (w/r)0 (w/r)1 Clothes L Steel L (w/r)0  (w/r)1 When r, w In Country II : (labor-abundant) Increase produce clothes i.e., Ic0Ic1 Decrease produce steel i.e., Is0Is1 Both industries now employ more capital

  26. Trade Condition Pc/Ps < (Pc/Ps) I (Pc/Ps)II < (Pc/Ps) (Pc/Ps)I world trade price Pc/Ps (w/r) (w/r)II < <(w/r)I (Pc/Ps)II Labor abundant country Capital abundant country 0 (w/r)II w/r (w/r)I w/r One important assumption is market perfect competition But in real world it seems FPE theorem does not work well.

  27. The Stolper-Samuelson Theorem With full employment both before and after trade, the increase in the price of the abundant factor and the fall in the price of the scare factor because of trade imply that the owners of abundant factor will find their real incomes rising and the owners of scarce factor will find their real incomes falling. In labor-abundant country: if price of labor-intensive goods  ---> wage  ---> producer of labor-intensive goods and labor income  In capital-abundant country: if price of capital-intensive goods  ---> capital rent  ---> producer of capital-intensive goods and capital owner income 

  28. Steel PC PS PC PS ( ) II < ( ) World price PC PS ( ) II A to P : PCW  (PS+ t)  r  P to T : A T P [Pc/(Ps+ tariff )]w Country II’s PPF 0 Clothes PCW  PS r  PC PS World price ( ) Example: Tariffs can increase the trade prices. (From red to green line) i.e., production point shifts from P point to T point Policy implication: Producer of steel and the capital ownerwill gain from the tariff. (Pro-tariff or welcome any protection). Producer of clothes and the labor will loss from the tariff. (Against tariff or reject any protection)

  29. Example: The Growth Effects of Labor-Market Adjustment and Migration ---LaborEndowment moves out, PPF shifts in. Autos (PT/PA) (PT/PA) a1 a0 t1 0 t0 Textiles Rybczynski Theorem: The effect of factor endowment change

  30. Autos (PT/PA) (PT/PA) a0 a1 Textiles 0 t0 t1 Rybczynski Theorem: Labor endowment increases, PPF shifts out

  31. Exercise: One of the important changes in the world economy over the past three decades has been the rapid increase in capital investment in the countries of the Pacific Basin (notably Japan, Korea). What are the implications of this investment for the commodity patterns of trade of these two countries, say, with respect to the United States? Explain. (Hint: Think about Rybczynski theorem)

  32. Invalid assumptions to Heckscher-Ohlin Model Case of Demand Reversal Steel Now Country-1 prefers more steel But Countyr-2 prefers more clothes C1 Country 1’s imports of S CI11 CI10 A1 P1 Country 1’s exports of C (Pc/Ps) world price CI21 CI20 P2 Country 2’s exports of S C2 A2 Cloth PPF1 PPF2 Country 2’s imports of C Country-1: capital abundant Country-2: labor abundant Steel: capital-intensive Clothes: labor-intensive Prediction of trade pattern from H-O model Country 2: exports C and imports S Country 1: exports S and imports C Demand Reversal outcome: Country 2: now exports S and imports C Country 1: now exports C and imports S

  33. Case of Factor-intensity: No matter factor prices change, factor relative requirement ratio is always unchanged. If steel is capital-intensive, cloth is labor-intensive,then at any factor prices ratio, the factor input ratio is always (K/L)s > (K/L)c At (w/r) : 2 K K ( ) > ( ) K L L L S2 C2 K ( )S2 W r ( ) 2 At (w/r) : K L 1 ( ) C2 K K ( ) > ( ) L L S1 C1 K L ( ) S1 F K L ( ) C1 G A Steel B 0 W r Labor Cloth ( ) 1 Steel: capital-intensive Clothes: labor-intensive

  34. Invalid assumptions to Heckscher-Ohlin Model Case of Factor intensity Reversal At (w/r) : 1 K K ( ) < ( ) L L C1 S1 K (w/r) 2 (k/L) C2 At (w/r) : 2 K K (k/L) S2 ( ) > ( ) L L C2 S2 F (k/L) S1 G Steel (k/L) C1 B Clothes A (w/r) 1 0 L

  35. Question: Can you give any example of tradable goods that may have such factor-intensity-reversal problem? Exercise: Show in a graph to illustrate that factor-intensity reversal can also occur of the two industry isoquants do not cross each other but are tangent to one another.

More Related