Heckscher-Ohlin Model Lecture Notes

Jul 26, 2024

Heckscher-Ohlin Model Lecture Notes

Introduction to the Heckscher-Ohlin Model

  • The focus of today’s discussion: Heckscher-Ohlin model (H-O model).
  • Key differences from previous models:
    • Two countries, two goods, but two factors of production (labor and capital).
    • Factors (labor and capital) are freely mobile between sectors.

Key Concepts and Assumptions

Factors of Production

  • Capital (K): Represented by C (for computers).
  • Labor (L): Represented by L.
  • Example goods used: S for shoes and C for computers.

Important Assumptions

  1. Factor Intensity:

    • Computer production is capital intensive (K > L).
    • Shoe production is labor intensive (L > K).
    • Capital to labor ratio in computers > ratio in shoes.
  2. Country Characteristics:

    • The home country is assumed to be capital abundant (higher capital to labor ratio compared to the foreign country).
    • Comparisons made on supply side (capital vs. labor).
  3. Technological Assumptions:

    • Both countries use the same technologies for shoe and computer production.
    • Ruling out reversals of factor intensity.
  4. Consumer Preferences:

    • Identical consumer preferences across both countries for simplification.

Production Possibility Frontier (PPF)

  • Home Country PPF:
    • Skewed towards computers (capital intensive).
    • Mostly produce computers and lesser shoes.
  • Foreign Country PPF:
    • Skewed towards shoes (labor intensive).
    • Mostly produce shoes and lesser computers.

Autarky Prices and Trade Predictions

  • Relative price predictions in autarky:
    • Home country (capital abundant) has a lower relative price for computers than the foreign country.
    • Comparative advantage: Home specializes in computers, while foreign specializes in shoes.
  • Upon opening to trade, home exports computers and imports shoes; foreign does the opposite.

Implications of Trade on Factor Returns

  • Trade leads to shifts in production and resources:
    • Home country sees increase in computer production and decrease in shoe production.
    • Foreign country shifts in the opposite direction.
  • Wage to rental rate ratio impacts:
    • Opening trade leads to a decrease in the wage rate for the labor-abundant factor in home and an increase in rental rate.
    • Opposite effect for foreign country.

Stolper-Samuelson Theorem

  • Payments to factors of production due to trade:
    • The abundant factor INCREASES in real return, and the scarce factor DECREASES in real return.
    • For home (capital abundant): rental rate increases, wage rate decreases.
    • For foreign (labor abundant): rental rate decreases, wage rate increases.

Factor Price Magnification Effect

  • Key Insight: Small changes in goods prices can lead to larger changes in wage and rental rates.
  • Implications for labor markets: Real wages for lower-skilled workers may decline significantly due to competition and trade dynamics.

Conclusion

  • Upcoming classes: empirical tests of the Heckscher-Ohlin model predictions.

Questions/Discussion

  • Discuss real-world implications of these theories on labor markets and trade policies.

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