Question

1. This problem uses the Heckscher-Ohlin model to predict the direction of trade. Consider the production of handmade rugs and assembly line robots in Canada and India.

a. Which country would you expect to be relatively labor-abundant, and which is capital-abundant? Why?

b. Which industry would you expect to be relatively labor-intensive, and which is capital-intensive? Why?

c. Given your answers to (a) and (b), draw production possibilities frontiers for each country. Assuming that consumer preferences are the same in both countries, add indifference curves and relative price lines (without trade) to your PPF graphs. What do the slopes of the price lines tell you about the direction of trade? Your graphs need to be carefully labelled.

d. Allowing for trade between countries, redraw the graphs and indicate the volume of imports and exports. Again, your graphs need to be carefully labelled.

2. Suppose when Japan opens to trade, it imports rice, a labor-intensive good.

a. According to the Heckscher-Ohlin theorem, is Japan capital-abundant or labor-abundant? Briefly explain.

b. What is the impact of opening trade on the wage in Japan?

c. What is the impact of opening trade on the rental of capital?

d. Based on your answers to (b) and (c), which group (capital owner or labor) would you expect to support policies to limit free trade?

Answer 1

India is relatively labour abundant because it has huge population and unemployment which reduce saving and capital formation whereas Canada will be more capital abundant as its population is less and per capita income is high so savings and investments are more and capital is more

b. Handmade rugs are labour intensive as it is made by hand which require more labour than capital and assembly line robots are more capital intensive as they need more machines than labour for production

in the above diagram we see that indifference curve I is common for both India and Canada due to identical tastes and it is tangent to PPF of nation 1India at A and tangent to PPF of nation 2 Canada at A' it is the case of no trade equilibrium relative commodity price of PA handrugs in nation 1 India and PA' in nation 2since PA is less than PA' India has comparative advantage in handmade rugs and canada in robots

Nation 2 Nation 2 PA Nation 1 A' A' Nation 1 E= E ΑΙ РА 20 0 20 40 60 80 100 120 FIGURE 5.4. The Heckscher nur 0 20 40 60 80 100 120

With trade india produce at point B and by exchanging rugs for robots reaches point E in consumption. Canada produces B' and by exchanging robots for rugs reaches E' and both nation reaches on higher indifference curve II

2. a. Yes Japan will import rice because according to heckscher ohlin theory a nation will export goods which require its relatively abundant factor and import goods which require its relatively scarce factor so japan import labour intensive rice so it is capital abundant

2. b. Wages in Japan will decreae because as it imports cheaper rice labour will get unemployed and wages will come to level of other labour rich nations where wage is low

2. capital will get more rental as due to cheap capital more production takes place and which increses demand and rental of capital

Labour union will support policies to limit free trade as due to imports demand for local rice decreases which create unemployment and decrease in wages