Question

The Heckscher–Ohlin model. Home and Foreign have two production factors, skilled and unskilled labor and produce two goods, textiles and computers. Home is skilled labor abundant, and computers are skilled labor intensive. Starting from a situation of autarky, the two countries liberalize trade. Assuming that the two countries produce both goods before and after trade liberalization, answer the following questions:

(a) What is the effect of trade liberalization on the relative price of computers at Home and in Foreign?

(b) What is the effect of trade liberalization on the output of computers and textiles at Home and in Foreign?

(c) What is the effect of trade liberalization on aggregate welfare in the two countries?

(d) What is the effect of trade liberalization on the real factor returns in Home and Foreign? Please provide a graphical explanation for your argument. What is the name of this famous result?

Answer 1

a- after trade liberalisation as home country is aboundant of skilled labour the country will produce more of computer and less of textile. like wise the foreign country will produce more of textile and less of computer as there will be trade between the two countries now it will be profitable for them to produce more of the goods they have aboundant factor of.

b- as a result of trade liberalisation the home country will produce more computer and less textile and will exchange computer for textile and the foreign country will produce more textile and less computer and will exchange textile for computer.

c- the aggregate welfare of the two countries will increase due to trade liberalisation as the countries will now specialise in the production of things that use the abundance factor of that country.

d- the real factor returns will be equalised and its called the factor price equalisation theorem stated by samuelson. according to the theory as a nation specialises in the production of the goods which uses the aboundance factor of it the demand for the abundance factor increases which ultimately pushes the respective remunaration to that factor and vice versa and as a result the cheap and abundant factor becomes costly and likewise the factor prices in both the nation are being equalised.