Int’l Trade & Agreements

THEORETICAL ANALYSIS OF INTERNATIONAL TRADE

I. The Ricardian Model

II. The Heckscher-Ohlin Model

III. The Specific Factor Model

 The Ricardian Model
Reporter: Jay Aura Balcita

I. The Classical Model: Differing Technologies

Overview
The first validated model of international trade is the Classical Model or also
known as the “Ricardian Model”. This model is originated by English political
economist David Ricardo in 1817.
It presents the concept of comparative advantage and provides evidence for
the possibility of successful trade between two countries. He also conveys that
without having tariffs, countries can benefit from balanced international trade.
Here, we concentrate on the technological or production disparities among
two countries. Whereas, the labor define the technology of production, and
having differences to these labor costs across countries represent the differences
in technology.
Countries can take advantage of these discrepancies by specializing in the
good for which their technology is relatively better and exporting that item in
return for the good for which their technology is relatively worse.
 The Ricardian Model
Reporter: Jay Aura Balcita

Absolute and Comparative Advantage Theory

Absolute advantage is the idea introduced by Adam Smith, where a manufacturer can offer a
product or a service in bigger quantities for the same cost, or in the same quantities for less
money, than its competitors. It was based on this concept that free trade could be advantageous
for countries.
Comparative advantage is the ability to produce goods and services at a lower opportunity
cost than its competitors. In order to analyze production costs and determine a country's
comparative advantage, they must compare the opportunity costs of manufacturing commodities
across countries. By free trade, specializing, and trading both countries will benefit.

It should also be noted that trade based on comparative advantage does not conflict with
Adam Smith's idea of advantageous trade based on absolute advantage. If both countries focused
on the products that they had a comparative and absolute advantage in, trade benefits may be
gained.
 The Ricardian Model
Reporter: Jay Aura Balcita

The Ricardian Model: Explained

Sample Illustration
  Germany USA
Cars 20 hours per unit 25 hours per unit
20/10 = 2 25/30 = 0.83

Cellphones 10 hours per unit 30 hours per unit

10/20 = 0.5 30/25 = 1.2

We can observe that per unit, Germany is able to create both items quickly. Germany has the absolute
advantage in both goods. To decide which product each country should produce, we must now employ
formulas. For every goods, we divide the amount of hours per unit for that good by the amount of hours per
unit of the other goods which the countries could produce. The good with the smaller ratio is the good the
country should be producing in comparison with the other result of the country. We can see the comparative
advantage through this.
 The Ricardian Model
Reporter: Jay Aura Balcita

The Ricardian Model: Explained

Individual Production Tr a de
  Costs for 50 Costs for 50 Units   Costs for 100 Costs for 100 Units
Units of Cars of Cellphones Units of Cars of Cellphones

Germany 1,000 hours 500 hours Germany 1,000 hours

USA 1,250 hours 1,500 hours USA 2,500 hours

Total: 4,250 hours Total: 3,500 hours Save: 750 hours

In general, Germany has the comparative advantage on producing cellphones and the USA on producing
cars. Both countries produce only the good in Furthermore, it shows
which they have that the global
the comparative output of both items could
advantage.
increase if Germany and USA each specialized in producing one of the two goods. In conclusion, in order to
maximize global output, the Ricardian model demonstrates that resources within nations should be distributed
to industries with each nation's comparative advantage, we should use every available resource on a global scale,
and we should let the nations engage in unrestricted trade.
 The Heckscher-Ohlin Model
Reporter: Kisha Mae Abellera

II. The Heckscher-Ohlin Model

What is Heckscher-Ohlin Model?

The Heckscher-Ohlin model is an economic theory proposes that countries export what they can most
efficiently and plentifully produce. It is used to evaluate trade and, more specifically, the equilibrium of
trade between two countries that have varying specialties and natural resources.

This theory is also called modern theory of international trade. Further, since this theory is based on
general equilibrium analysis of price determination, this is also known as General Equilibrium Theory of
International Trade.

It also emphasizes the import of goods that a nation cannot produce as efficiently. It takes the position
that countries should ideally export materials and resources of which they have an excess, while
proportionately importing those resources they need.
 The Heckscher-Ohlin Model
Reporter: Kisha Mae Abellera

THE HECKSCHER-OHLIN MODEL: An intuitive approach

The Heckscher-Ohlin Theory is a theory of trade in which factors are the driving
force behind price and value changes. The development of this theory is generally
associated with two Swedish economists, Heckscher and Ohlin. Sometimes it is used
to refer to all models in which differences in factor endowments are the key driver of Eli Filip
Bertil Ohlin
Heckscher
trade. It is also a model with two goods and two factors in which both factors are
mobile between or useful in both industries.

The two-factor Heckscher-Ohlin model is considerably richer than the Ricardian model and allows for
more realistic predictions. Because the frontier is "bowed out“ countries will have much less of a tendency to
specialize. And Heckscher-Ohlin model allows for interesting and important income distribution effects from
trade.
 The Heckscher-Ohlin Model
Reporter: Kisha Mae Abellera

The Factor-Price-Equalization Theorem

Factor-price-equalization is the idea that trade in goods can equalize the price of each factor of
production across countries, even though the factors themselves are not traded. Trade in goods indirectly
creates competition for other factors embodied in the goods trade.

Factor-price equalization theorem.

1. If two undistorted competitive economies have identical technologies.
2. Costless trade equalizes commodity prices between countries, and;
3. Both countries produce both goods in equilibrium, then the price of each factor is equalized across
countries.
 The Heckscher-Ohlin Model
Reporter: Kisha Mae Abellera

The Rybczynski Theorem

The Rybczynski theorem concerns the effect of changing endowments on output holding commodity prices
in constant. It is valid only under the assumption that a country is non specialized, producing both goods. If
commodity prices are held constant and a country is producing both goods, then factor prices are determined
and constant.
Furthermore, it emphasizes that, at least for a fairly small country that has little influence over world
prices, large changes in the country's factor endowment may be absorbed by changing the composition of
output with very little effect on factors prices. This is very different from the way that labor economists
conceptualize the economy using the partial-equilibrium tools of supply and demand. The general equilibrium
Rybczynski theorem says that at constant world prices, the labor (or capital) demand curve is flat and big
changes in supply may have little effect on the wage (or return to capital).
 The Heckscher-Ohlin Model
Reporter: Kisha Mae Abellera

The Stolper-Samuelson Theorem; Empirical Evidence on Factor Endowments and Trade

The Stolper-Samuelson Theorem

An increase in the price of one good causes a more than proportional increase in the price of the factor
used in making that good and a decrease in the price of the other factor, all other things being equal. Like
Rybczynski, it has nothing to do with international trade specifically, but it does provide light on a variety
of external economic shifts and the implications of domestic trade liberalization or protectionist policies
on income distribution. The country's income is redistributed as a result of these policies and supply
disruptions that alter commodities trading prices.
Empirical Evidence on Factor Endowments and Trade
The Heckscher-Ohlin model make a series of strong assumptions in order to isolate the effects of
different relative factor endowments on trade between two countries. These assumptions included
identical technologies with constant returns to scale, perfect competition, no factor-intensity reversals,
identical and homogenous preferences, the absence of international factor migration, and no
impediments to trade.
 The Specific Factor Model
Reporter: Angelyka Sipod

III. The Specific Factor Model

Overview
Jacob Viner (1892-1970) first examined the specific factors model, which is a
variant of the Ricardian model.

It was further developed by Paul Samuelson and Ronald Jones. It is also called
the Ricardo-Viner model. Michael Mussa (1974) developed the graphical approach
to illustrate the main results of this model. In contrast to the Ricardian model, this
model includes two specific factors.

Viner designed the model to explain the migration of workers from the rural to urban
areas after the Industrial Revolution in the 1820s. Specific or fixed factors suffer of urban
life much more than the mobile factor, labor.

Two of the factors are “specific” factors, each having a use in only one industry and having
no use in the other. The third factor is mobile and can costlessly move between the two
sectors as both factors do in the Heckscher-Ohlin model.
The Specific Factor Model
Reporter: Angelyka Sipod

Specific Factors

2 Countries 2 Sectors
Home and Foreign Manufacturing and Agriculture

3 Factors

1. Labor is the mobile factor that can move between the two sectors.
2. Capital (K) specific to manufacturer
3. Land (T) specific to agriculture
The Specific Factor Model
Reporter: Angelyka Sipod

Specific Factors Model

The Ricardian Model The Heckscher-Ohlin Model The Specific Factor Model

Reporters

Abellera, Kisha Mae

Balcita, Jay Aura

Sipod, Angelyka

BSBA 3

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