Heckscher-Ohlin Model of Trade

(Chapter 5, Textbook)
Two factor economy
QC = QC (KC, LC),
QF = QF (KF, LF),

u aKC = capital used to produce one yard of cloth

u aLC = labor used to produce one yard of cloth
u aKF = capital used to produce one calorie of food
u aLF = labor used to produce one calorie of food
Production possibility frontier with
factor substitution
Value of production:
V = PC x QC + PF x QF
Profit maximization for perfectly
competitive firm
Factor Prices and Input Choices
u ratioof labor to capital
used in production
depends on the cost of
labor relative to the cost
of capital, w/r
u Cloth production: L-
intensive
u Food production: K-
intensive
Factor Prices and Goods Prices
From goods prices to input prices
Resources and production
u Increase in L supply
u Economy able to produce
more goods
u But biased toward Cloth
production which is L-
intensive
u Fall in food output
Resources and production

u Generally, an economy will tend to be

relatively effective at producing goods that are
intensive in the factors with which the country is
relatively well endowed.
Effects of international trade
Short and long run equilibrium
u2 countries: Home, Foreign
u Same tastes, same
technology
u Home: L-abundant
u Foreign: K-abundant
u Trade leads to
convergence of relative
prices
u Also factor prices (factor
price equalization)
Factor Prices and Goods Prices
Heckscher-Ohlin Theorem

Hecksher-Ohlin Theorem: The country that is

abundant in a factor exports the good whose
production is intensive in that factor.
Trade and income distribution

u Owners of a country’s abundant factors gain from

trade, but owners of a country’s scarce factors
lose.
u Specific factors model: same conclusion
q In the long run factors are mobile
u Heckscher-Ohlin model: Resource differences
harder to address; effects of trade on income
among land, labor, capital relatively permanent
Increasing inequality in the US
u Is it because of trade? Should have evidence of:
v Relative price change: Rise in the prices of skill-intensive
products compared with those of unskilled-labor-intensive
goods
v Relative factor prices should converge across countries
v Trade between advanced countries and NIEs has grown
rapidly, but comprises only a small fraction of total
spending in advanced countries
u More plausible reason: skill-biased technological change
u US: Ratio of non-
production to
production
employment has
increased
u Trade may also
have hastened
technology change
u Outsourcing
production labor to
other countries
Skill-Biased Technological Change
and Income Inequality
Declining share of labor in income
Leontief paradox
u US workers work with more capital per person than other
countries, i.e. higher capital-labor ratio than others
u But US exports less capital-intensive than its imports