Ricardo, David (1817): On the Principles of Political Economy and Taxation . London.

1. Ricardo, David (1817): On the Principles of Political Economy and Taxation. London. Heckscher, Eli (1919): The Effect of Foreign Trade on the Distribution of Income, Ekonomisk Tidskrift, 497-512. Ohlin, Bertil (1933): Interregional and International Trade. Cambridge, Mass. Krugman, Paul (1980): Scale Economies, Product Differentiation, and the Pattern of Trade. American Economic Review 70, 950-959. Markusen, James R. (1981): Trade and the Gains from Trade with Imperfect Competition. Journal of International Economics 11, 531-551. Helpman, Elhanan (1984): A Simple Theory of International Trade with Multinational Corporations. Journal of Political Economy 92, 451-471. Markusen, James R. (2002): Multinational Firms and the Theory of International Trade. Cambridge, Mass. Source: van Marrewijk, C. (2002): International Trade and the World Economy. Oxford et al.

2. Differences in Endowments: The Heckscher-Ohlin Model • Ricardo-Model: Trade due to differences in labor productivity • Heckscher-Ohlin Model: Trade due to differences in factor endowments, technologies identical across countries • Assumptions: • perfect competition in all markets • two countries • two homogenous goods, computer and clothes • linear homogenous production technologies, identical for both countries: computer, clothes

3. two homogenous factors of production, capital K and labor L, supply completely price inelastic • factors of production mobile between sectors, but immobile between countries • general equilibrium model: goods and factor prices lead to an equilibrium on all goods and factor markets • homothetic preferences, identical across countries

4. Notation: factor input coefficients: first index: factor of production, second index: good labor per unit computer capital per unit computer labor per unit clothes capital per unit clothes factor endowments: labor, Germany capital, Germany labor, China capital, China

5. Deriving the factor input coefficients: graphical:  Minimize per unit cost, given that one unit of output is produced: Figure 1 per unit production isoquant • iso-cost line

6. With Cobb-Douglas production technologies:

7. ...and for computer: Assumption: , computers more capital intensive in production, compared to clothes  computer capital intensive, clothes labor intensive figure 2 clothes, slope computer, slope no reversal in factor intensities

8. relative goods prices and relative factor prices perfect competition on goods and factor markets zero profit conditions hold: in the example:

9. > 0 figure 3 Stolper-Samuelson Theorem (weak version): In a neoclassical framework with two final goods and two factors of production, an increase in the relative price of a final good increases the relative price of the factor of production used intensively in the production of that good and reduces the reward to the other factor, provided both goods are produced.  Opening up a country to international trade may generate conflicts between households

10. Merging both figures: figure 4 computer clothes  unique relationship between relative goods prices and factor input ratio: An increase in the relative price to leads to an increase in the labor intensity in producing both goods.

11. Stolper-Samuelson Theorem (strong version): In a neoclassical framework with two final goods and two factors of production, an increase in the relative price of a final good increases the real reward - in units of both goods - of the factor of production used intensively in the production of that good and reduces the real reward - in units of both goods - to the other factor, provided both goods are produced. Example: see figure 2: clothes computer see figure 3:

12. see figure 4 Furthermore, due to profit maximizing factor input of firms, factor price = marginal value product Stolper-Samuelson Theorem (strong version): An increase in (pC/pK) leads to an increase in (aLC/aKC) as well as (aLK/aKK) - capital gains in units of computer as well as in units of clothes An increase in (pC/pK) leads to a decline in (aKC/aLC) as well as (aKK/aLK) - labor looses in units of computer as well as in units of clothes

13. Factor endowments and goods production Assumption: relative goods prices constant (see previous slide) relative factor prices constant Edgeworth-Box for a country, e. g. Germany: figure 5 0K 0C

14. Increase in the relative and absolute capital endowment of Germany: ( decrease in the relative labor endowment of Germany) figure 6 0K‘ 0K 0C absolute and relative production of computer increases, absolute and relative production of clothes declines

15.  Rybczynski-Theorem: In a neoclassical framework with two final goods, two factors of production, and constant prices of the final goods, an increase in the supply of one of the factors of production results in an increase of the output of the final good that uses this factor of production intensively and a reduction in the output of the other final good, provided both goods are produced in equilibrium. Expansion to two countries, Germany and China: • identical homothetic preferences: identical relative demand for computer and clothes, if relative prices are identical • identical production technologies: identical factor input leads to identical output • different relative factor endowments: Germany is relatively well endowed with capital (“relative” to labor, “well” in comparison to China), China is relatively well endowed with labor (“relative” to capital, “well” in comparison to Germany).  Heckscher-Ohlin Theorem: In a neoclassical framework with two final goods, two factors of production, and two countries which have identical homothetic preferences, a country will export the good which intensively uses the relatively abundant factor of production.

16. Example: • Germany relatively well endowed with capital •  China relatively well endowed with labor • Computer production intensive in capital •  clothes production intensive in labor Germany exports computer, China exports clothes

17. relative demand for computer, identical across countries due to identical homothetic preferences figure 8 relative supply of computer, China Relative supply of computer, Germany Relative supply of computer, Germany, larger than China’s relative supply of computer due to Rybczynski-Theorem Relative supply of computer, China Relative demand for computer, Germany Relative demand for computer, China II I III IV V I: relative supply of China, free trade II: relative supply = relative demand of China, autarky III: relative demand of both countries, free trade IV: relative supply = relative demand of Germany, autarky V: relative supply of Germany, free trade

18. Graphical “proof” of the Heckscher-Ohlin theorem:  A country achieves a higher level of welfare, if it specializes according to the Heckscher-Ohlin theorem (Maintained assumption: Costless restructuring) figure 9 Germany China

19. Goods trade and intranational income distribution: Germany:  Opening Germany up to free trade leads to an increase of the relative price of computer;  Stolper-Samuelson Theorem: relative and real reward of capital increases, relative and real reward of labor declines  Opening Germany up to free trade leads to an increase in real factor income for households, which are endowed with the factor the country is relatively well endowed with. Households, which are endowed with the factor the trade partner is relatively well endowed with, loose in real factor income, if the country is opened to free trade.

20. Goods trade and factor price equalization: Trade leads to equalization of relative and absolute goods prices:  Equalization of relative and absolute factor prices: see figure 3 figure 3 definite relationship between relative goods prices and relative factor prices goods trade is a perfect substitute to factor trade: Germany exports capital, which is embodied in the exports of computers, China exports labor, which is embodied in the exports of clothes

21.  No convergence in factor prices; Reason?  factor market equilibrium conditions: Germany: China: zero profit conditions: Germany: China: If the number of goods is larger/equal to the number of factors of production ( number of zero profit conditions is larger/equal to the number of factors), if trade leads to identical goods prices across countries, and if the production technologies are identical across countries ( ) identical zero profit condition are solved for the factor prices in both countries. Factor price equalization theorem

22. Factor price equalization results. • Possible reasons for incomplete factor price equalization: • specialization in production, Germany only produces computer, China produces only clothes • only one zero profit condition per country, determination of factor prices also requires factor market equilibrium conditions; •  differences in relative factor endowments lead to differences in absolute factor prices • differences in production technologies, •  zero profit conditions may be solved for the factor prices, however, not identical zero profit conditions are solved for factor prices • no equalization of goods prices due to tariffs, transport costs, etc. •  right hand sides of the zero profit conditions are not identical