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.

[Music]