Question

ishes, (b) increases, (e) remains unehanged, l Problems THE HECKSCHER-OHLIN THEORY 3.1 (a) Identify the conditions that may give rise to trade between two nations. (b) What are some of the assumptions on which the Heckscher-Ohlin theory of trade is based? (c) What does this theory say about the pattern of trade and effect of trade on factor prices? uppose that (1) the capital-labor ratio (Le , KL) to produce l unit of wheat is greater than theKL produce I unit of cloth (i.e., wheat is K-intensive relative to cloth) in both the U.S. and the U.K.: (2) the ratio of total capital to total labor available in the U.S. is greater than in the U.K.; (3) the taste for wheat and cloth is the same in both nations:(4) each nation faces increasing costs of production; and (5) the same technology is available to both nations. (a) Indicate how the U possibilities curve would differ from that of the U. K. (b) In which nation is the price of capital (i.e., the interest rate, r) relative to the price of labor time (i.e., the wage rate, w) lower? Why? (c) Which nation in isolation will have the lower equilibrium P/Pc? Why? 28

Answer 1

3.1.a.According to Heckscher-Ohlin theory of trade , differences in factor endowments and difference in factor proportions of producing different commodities causes differences in comparative costs between two nations. Hence, there are basically two conditions for trade :

1. Different countries have different factor endowments (some countries are labor intensive while some are capital intensive).

2. Factor-proportion (Capital/Labor ratio) for production of different goods are different.

b. Assumptions for Heckscher-Ohlin theory are as follows:

1. Country A is relatively capital intensive and country B is relatively labor intensive. (K_A/L_A > K_B/L_B)

2. Price of a capital intensive good is cheaper in a capital intensive country and price of a labor intensive good is cheaper in labor intensive country.{(PK/PL)_A < (PK/PL)_B}

3. Factor inputs can freely move between the two countries.

4. Consumers have same taste and preference across the countries.

5. Technology used in production of goods is similar for both countries.

c. According to Heckscher-Ohlin theory, country A having a relative abundance of capital will specialize in the production of capital intensive good and export it to country B. In exchange, country B will specialize in production of labor intensive good and export it to country A. The theorem says, due to trade , when the prices of exchanged goods between countries are made equal, factor prices will also become equal.