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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?
Answer Given Canada’s relatively small population (approximately 30 million
compared with more than 1 billion in India) and level of development, it is a
safe assumption that LCAN/KCAN , LIND/KIND. That is, there is more capital per
worker in Canada, making it capital-abundant compared with India. Similarly,
India would be labor-abundant.
b. Which industry would you expect to be relatively labor-intensive, and which is
capital-intensive? Why?
Answer: Given the amount of capital required to produce robots and the
amount of labor required to produce rugs, one would expect that LROBOT/
KROBOT , LRUG/KRUG, making robots capital intensive and rugs labor intensive.
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?
S-31
S-32 Solutions n Chapter 4
Solutions n Trade and 4Resources:
Chapter Trade andThe Heckscher-Ohlin
Resources: Model
The Heckscher-Ohlin Model S-32
slope = PRO/PRU
slope = P * /P *
RO RU
Exports
A*
Imports
A Imports
Exports
2. Leontief’s paradox is an example of testing a trade model using actual data observa-
tions. If Leontief had observed that the amount of labor needed per $1 million of U.S.
exports was 100 person-years instead of 182, would he have reached the same conclu-
sion? Explain.
Answer: If the amount of labor required for $1 million of U.S. exports was 100
person-years instead of 182, then the capital/labor ratio for exports would have been
$25,500 per person. Because this is larger than the corresponding ratio for imports,
this test would have provided support for the Heckscher-Ohlin theorem. That is, the
United States (which was assumed to be capital-abundant in both cases) would have
been shown to export capital-intensive goods. In actuality, however, Leontief’s test
showed exactly the opposite.
S-33 Solutions n Chapter 4
Solutions n Trade and 4Resources:
Chapter Trade andThe Heckscher-Ohlin
Resources: Model
The Heckscher-Ohlin Model S-33
in wage (–55%) and the prices of the outputs stayed the same for computers or
increased for shoes, labor loses in real terms. This is consistent with the Stolper-
Samuelson theorem: In the long run, when all factors are mobile, an increase in
the relative price of a good will cause the real earnings of labor and capital to
move in opposite directions, with a rise in the real earnings of the factor used
intensively in the industry whose relative price went up and a decrease in the
real earnings of the other factor.
4. Using the information in the chapter, suppose Home doubles in size and Foreign
remains the same. Show that an equal proportional increase in capital and labor at
Home will change the relative price of computers, wage, rental on capital, and the
amount traded but not the pattern of trade.
Answer: An equal proportional increase in Home’s capital and labor does not
change its relative factor endowments so that the labor/capital ratio is unchanged.
With constant factor prices, your graph should show that the no-trade equilibrium
doubles. Further, the no-trade equilibrium in Foreign is unaffected because its size
remained unchanged. At the original world relative price of computers, the quantity
exported by Home exceeds the quantity Foreign wants to import, leading to a drop
in the relative price. The lower free-trade relative price of computers decreases the
rental on capital. However, labor is better off in real terms as a result of the decrease
in the relative price of computers from free trade. The pattern of trade remains the
same although the amount traded has increased. The pattern of trade is consistent
with the Heckscher-Ohlin theorem. Despite the proportional increase in its endow-
ments, Home is still capital-abundant, and it continues to export capital-intensive
goods.
QS
A*
QC
5. Using a diagram similar to Figure 4-12, show the effect of a decrease in the relative
price of computers in Foreign. What happens to the wage relative to the rental? Is
there an increase in the labor/capital ratio in each industry? Explain.
Answer: With free trade the labor-abundant Foreign country will increase production
of the labor-intensive good (shoes), leading to a rightward shift of the relative demand
curve from RD * to RD * . At the new equilibrium point B *, computers are weighted
1 2
less, a fall in (K * /K ), whereas the shoe industry is weighted more, a rise in (K S /K
w ).
C w* * *
As a result of the rise in the relative demand for labor in the shoe industry, the relative
wage increases, which in turn lowers the labor/capital ratio in both industries.
S-35 Solutions n Chapter 4
Solutions n Trade and 4Resources:
Chapter Trade andThe Heckscher-Ohlin
Resources: Model
The Heckscher-Ohlin Model S-35
B*
increases from (W*/R*)1
to (W*/R*)2
A*
(W*/R* )1
L*S /KS*
RD2*
d. Which group (capital owner or labor) would support policies to limit free trade?
Briefly explain.
Answer: The capital owners will support policies to limit free trade because
they suffer a loss due to the decrease in the relative price of automobiles when
Russia engages in trade.
7. In Figure 4-3, we show how the movement from the no-trade equilibrium point
A to a trade equilibrium at a higher relative price of computers leads to an upward
sloping export supply, from points A to D in panel (b).
a. Suppose that the relative price of computers continues to rise in panel (a), and
label the production and consumption points at several higher prices.
Answer: See the following figure.
Output Relative
of shoes, price of
QS computers,
(PC /PS ) W 1 PC /PS
D2
(PC /PS ) W 1.5
C2 1.25
C1
B1 0.75
B2
10 20 30 40 Output of 5 10 15
computers,
QC
Relative
price of
computers,
PC /PS
1 Home
D2 exports
(PC /PS ) W2 1.50
1.25
0.75
(PC /PS ) A 0.50 A
Foreig
n
import
s
Output of 5 10 15 Quantity
computers, of
QC computer
s
(b) International
Market
c. What happens to the export supply curve when the price of computers is high
enough? Can you explain why this happens? Hint: An increase in the relative
price of a country’s export good means that the country is richer because its
terms of trade have improved. Explain how that can lead to fewer exports as
their price rises.
Answer: As the world-relative price for computers rises, this is a terms-of-trade
gain for the Home country, which exports computers. From the point of view of
Home consumers, it is like a rise in income, so they consume more of both com-
puters and shoes (the income effect). On the other hand, the rise in the relative
price of computers leads them to substitute away from this good (the substitution
effect). When the income effect dominates the substitution effect, as will occur for
sufficiently high increases in the terms of trade, then exports of computers will fall
due to increased Home demand.
8. On March 2, 2013, Tajikistan successfully negotiated terms to become a member
of the World Trade Organization. Consequently, countries such as those in western
Europe are shifting toward free trade with Tajikistan. What does the Stolper-Samu-
elson theorem predict about the impact of the shift on the real wage of low-skilled
labor in western Europe? In Tajikistan?
Answer: According to the Stolper-Samuelson theorem, the real wage of unskilled
labor in Western Europe will experience a decrease in real earnings because Western
Europe is skilled-abundant relative to Tajikistan and will specialize in the skilled-
intensive good. By trading with Tajikistan, the relative price of the skilled-intensive
good will rise. In Western Europe, this leads to an increase in the real earnings of
skilled labor and a decrease in the real wage of unskilled labor. The situation would
be opposite in the Tajikistan, where the real wage of unskilled labor would increase.
9. The following are data on U.S. exports and imports in 2012 at the two-digit Har-
monized Tariff Schedule (HTS) level. Which products do you think support the
Heckscher-Ohlin theorem? Which products are inconsistent?
S-38 Solutions n Chapter 4
Solutions n Trade and 4Resources:
Chapter Trade andThe Heckscher-Ohlin
Resources: Model
The Heckscher-Ohlin Model S-38
Export Import
HTS Level Product ($ billions) ($ billions)
Answer: Because the United States is relatively abundant in skilled labor and scarce
in unskilled labor, as predicted by the Heckscher-Ohlin model the U.S. imports
unskilled-labor–intensive goods such as apparel, footwear, furniture, and toys. As-
suming pharmaceutical products use skilled labor, U.S. imports of these goods are
contrary to the prediction of the model. Both skilled labor and capital are used inten-
sively in the production of aircraft, and given that the United States has abundance in
both factors, the export of this good supports the Heckscher-Ohlin model. However,
the model is unsupported by the import of electric machinery and vehicles as both
goods also use intensively skilled labor and capital. The export of cotton is also likely
to contradict the Heckscher-Ohlin model because the United States is relatively land
scarce.
10. Following are data for soybean yield, production, and trade for 2010–2011:
Suppose that the countries listed in the table are engaged in free trade and that soy-
bean production is land-intensive. Answer the following:
a. In which countries does land benefit from free trade in soybeans? Explain.
Answer: Landowners in the United States, Brazil, and Canada benefit from free
trade since the production of soybeans intensively uses land as a factor of produc-
tion, since these countries export more soybeans than they import.
S-39 Solutions n Chapter 4
Solutions n Trade and 4Resources:
Chapter Trade andThe Heckscher-Ohlin
Resources: Model
The Heckscher-Ohlin Model S-39
b. In which countries does land lose from free trade in soybeans? Explain.
Answer: As net importers of soybeans, landowners in Australia, China, Mexico,
Japan, Russia, and France lose from free trade because the world-relative price
of soybeans is lower than each country’s no-trade equilibrium price.
c. In which countries does the move to free trade in soybeans have little or no ef-
fect on the land rental? Explain.
Answer: None.
11. According to the Heckscher-Ohlin model, two countries can equalize wage differ-
ences by either engaging in international trade in goods or allowing high-skilled and
low-skilled labor to freely move between the two countries. Discuss whether this is
true or false, and explain why.
Answer: Allowing skilled workers to migrate to skilled-labor-scarce countries
and unskilled workers to migrate to unskilled-labor-scarce countries reduces the
ratio of skilled/unskilled workers in the skilled-labor-abundant country and raises it
in the unskilled-labor-abundant country. This increases the wage ratio between
skilled and unskilled labor in the skilled-labor-abundant country and lowers it in
the unskilled-labor-abundant country.
When the two countries trade in goods that embody these factors, the skilled-labor-
abundant country will export the skilled-labor-intensive good. By doing so, it ef-
fectively sends a lot of skilled workers and a few unskilled workers to the unskilled-
labor-abundant country. Likewise, when it imports the unskilled-labor-intensive
good, it effectively imports a few skilled workers and a lot of unskilled workers. The
net effect is skilled workers in the unskilled-labor-abundant country see a fall in their
wage relative to unskilled labor and unskilled workers experience a rise in their rela-
tive wage, similar to that of migration.
When all the strict assumptions of the Heckscher-Ohlin model are satisfied, we can
get this factor price equalization theory: trade leads to equalization of returns to fac-
tors across countries. As product prices in two countries converge to the same world
price level, the difference in the factor prices narrows, and ultimately disappears. But
this theory should not be viewed as Holy Grail as it requires “extraordinary demand-
ing” assumptions that are not quite satisfied in the reality.
12. According to the standard Heckscher-Ohlin model with two factors (capital and
labor) and two goods, movement of Turkish migrants to Germany would decrease
the amount of capital-intensive products produced in Germany. Discuss whether this
is true or false, and explain why.
Answer: An increase in a factor of production raises the production of the good
that uses that factor intensively and reduces the production of the other good. So as
labor flows from Turkey to Germany, labor endowment increases in Germany. The
production of labor-intensive goods relative to capital-intensive goods will increase
in Germany.