Question

Suppose France and England only trade with each other; each produces ale and bread; the production of bread is relatively labor intensive, and the production of ale is relatively capital intensive; France is relatively labor abundant and England is relatively capital abundant.

According to the HO model, free trade between England and France should cause the prices of English bread and French ale to _______________. Why?

According to the HO model, free trade between England and France will do what to the factor prices (wages and interest) in the two countries?

Using the Stolper-Samuelson theorem, would you expect workers in France to favor limiting trade? Why or why not?

Suppose that the price of ale has risen by 10%, then which of the following can you say for sure about England?

1. The interest rate returns in England will rise by more than 10%
2. The interest rate returns in England will rise by less than 10%
3. The wage rate in England will rise by more than 10%
4. The wage rate in England will rise by no more than 10%

Suppose that the price of bread has risen by 5%, then which of the following can you say for sure about France?

1. The interest rate returns in France will rise by more than 10%
2. The interest rate returns in France will rise by less than 10%
3. The wage rate in France will rise by more than 10%
4. The wage rate in France will rise by no more than 10%

The following are data on US exports and imports. Which products do you think support the HO model? Which products are inconsistent? Explain.

Imports and Exports (billions USD) in 2006 HS Industry Exports 2.7 25.2 6.5 2.5 0.8 12.6 6.5 Imports 30 52 61 64 72 74 85 87 Beverages Pharmaceutical products Cotton Apparel Footwear Iron and steel Copper Electric machinery Vehicles Aircraft Furniture Toys 16.2 42.3 1.5 35.5 19.1 28.9 14.2 229.2 215.4 17.6 39.8 25.9 145.8 92.7 66. 94 95 Source: International Trade Administration, U.S. Department of Commerce, 2007. 7.6 5.5

Answer 1

1. According to the HO model, free trade between England and France should cause the prices of English bread and French ale to be higher.

Reason: One of the assumption of HO theory is that commodity prices depend on the availability of factors.

Since england is capital abundant. So it will have less supply of labour. Since bread is labour intensive commodity so it will be costlier to make english bread.

Similarly, france is a labour abundant country and ale is capital intensive product. So it will be costlier for france to make ale.

2. In England, because england is capital abundant so it will specialize in production of capital intensive good. So demand for capital will rise and hence price of capital will increase I.e. rent will increase. ​ Since England will manufacture less of ale so demand of labour will decline. Hence wages of labour will decline.

France is labour intensive, so it will specialize in making labour intensive good - bread. So demand of labour  will rise and hence price of labour will increase I.e. wages will increase. Now since France will manufacture less of ale so demand of capital will decline. Hence rent of capital will decline.

3. No, workers in France will not favour limiting trade.

As France is labour intensive country so it will export bread, due to which demand and wages of labour will increase. Limiting trade will result in decline in demand of labour. Workers would not want that. So they will go in favour of boosting trade. And not limiting it.  

4. (b). The interest rate returns in England will rise by less than 10%

Since England is producing Ale so increase in price will lead to increase in interest rate of capital by stopler Samuelson theorem.

5. (D). The wage rate in France will rise by no more than 10%

Since France is producing bread so increase in price will lead to increase in wage rate of labour by stopler Samuelson theorem.