4 Week (Tuesday, Sept. 6, 2011)
Review final portion of previous
Lecture
Introduce Chapter 4
Trade: Factor Availability and
Factor Proportions are Key
Suppose Wheat, Cloth and
Shoes
Suppose:
aw/aw* < as/as* < ac/ac*
U.S. exports W
U.S. imports C
Case 1:
aw/aw* = .5 < as/as* = .75 < ac/ac*
= .90
Case 2:
aw/aw* = 1.3 < as/as* = 1.5 < ac/ac*
= 4.0
What about S?
Need /*
When
Pw/Pw* = aw/ *aw* < 1
RoW imports
When
Key:
(aw/aw*) < (*/)
1 < aC/ *aC* = PC/PC*
RoW exports
High
Foreign
wages
hurt
High
Foreign
wages
offset
c
by
productivity
advantage
(*/) < (ac/a *)
(*/) vs (as/as*)
What about S?
Case 1
aw/aw* < as/as* < ac/ac*
(*/)
Row export S
Case 2
aw/aw* < as/as* < ac/ac*
(*/)
RoW import S
* influenced by the average level of the as
Testing the Ricardo Model
How well does it predict?
GDA MacDougalls 1954 Study
Data for U.K. and U.S. exports to third
countries shortly after WWII
U.S. Exports to i/U.K Exports to i
U.S. industry ABSOLUTELY more
productive in all 13 industries for
which data was available
U.S. wages over 2x those in U.K.
G.D.A. MacDougalls 1951 Data
Industry
a
uk
Output per
U.S. Worker
-------------------
aus
Output per
U.K. Worker
Pig Iron
Motor Cars
Machinery
Glass Containers
Paper
Cigarettes
Leather Footwear
Hosiery
Cotton Spinning
Beer
Cement
Wool
Apparel
3.6
3.1
2.7
2.4
2.2
1.7
1.4
1.8
1.5
2.0
1.1
1.35
1.25
U.S. Exports to
Third Market
(Market Share)
-------------------U.K. Exports to
Third Market
(Market Share)
5.1
4.3
1.5
3.5
1.0
.47
.32
.30
.11
.056
.091
.004
.044
(*/) and (as/as*)
(*as*)/(as)
Conclusion
Trade patterns between countries are
determined to a significant degree by
relative differences in their labor
productivities.
This simple theory has impressive
empirical support.
Consider New Theory
Recall: Basic Determinants of
Prices
Demand:
Tastes or preferences
Income
Supply:
Technology**
Ch. 3--Ricardo
Cost of inputs**
Ch. 4HecksherOhlin
Government Policies:
Taxes, subsidies
Key Result
Begins with assumption that relative
supplies or relative amounts of resources
differ across countries (technology the
same)
Autarky prices and production costs are
determined by the (relative) amounts of
resources.
Benefits of this Model
Corrects two limitations of Ricardo
model:
Trade leads to specialization (since
MC is always constant)
No income distribution effects (since
only one factor of production)
This more realistic model will better
explain why free trade is
controversial.
Key Task
Understand how different
relative amounts of resources
across countries translate into
different autarky prices across
countries.
Graphical Determination of Price
DIFFER
Price
Inputs)
WHY INPUT COSTS
S(Tech, Cost of
Po
income)
D (tastes,
New More Realistic Model
Within a country
Two Goods: C and W
The production of each requires two
resources: labor (L) and Land (T)
Factor Intensity of Products
New Characterization of products:
How the two resources are combined to
produce a unit of the product
Land intensity computed as T/L
Labor Intensity computed as L/T
Land Intensity & Land Intensive
Compute the land intensity of C and
W
Assume C and W produced using
different relative amounts of L and T
IF
Tw/Lw
>
Tc/Lc
We say wheat production is land
intensive relative to cloth
production
Land Intensity & Land Intensive
Suppose we find that
Tw/Lw < Tc/Lc
Then we say:
Cloth production is land
intensive relative to wheat
production
Example Land Intensity
ONE UNIT OF WHEAT divide Tw by Lw
Tw/Lw = 10 acres / 2 hrs = 5
acres/hr
ONE UNIT OF CLOTH divide Tc by Lc
Tc/Lc = 20 acres / 10 hrs = 2
acres/hr
Take Inverse for Labor Intensity
Cloth must be labor intensive:
Since Tw/Lw
>
Tc/Lc
the inverse is
Lw/Tw <
Lc/Tc
Example Intensity
ONE Labor UNIT OF WHEAT
2 hrs / 10 acres = 1/5 hr/acre
ONE UNIT OF CLOTH
10 hrs / 20 acres = hr /acre
Thus, Lw/Tw <
Lc/Tc
A major implication of
different factor intensities:
Rising Opportunity Cost
As more of a product is
produced, its marginal cost
rises.
Why Rising Opportunity Cost?
As more of a product is produced, it
requires more T and L.
T and L must be released from the other
industry.BUT, not released in the right
proportion.
If expanding industry needs lots of labor and
little land, the other industry is releasing little
labor and lots of land.
RESULTincreasingly costly to expand
output.
As we
produce
more C and
less W
Mc/Mw
rises
from 1 W/C
to 3 W/C
Why is rising opportunity cost
important?
It means that a country will continue to
produce a product after a price
increase.
In Ricardo model, MC stays the same,
so if P> MC, it makes sense to continue
to produce more of the good. Here, as
more is produced, MC rises towards P.
Introduce Demand
U.S. likes 3 W & 1 C
U.S. likes 1 W
&1C
Wheat
Wheat
6
3
3
12
Cloth
3
Now Lets Combine Demand and
PPC to arrive at the autarky
equilibrium Pc/Pw
Autarky
Wheat
MCc/MCw <
Pc/Pw
Sw
Dw
Sc
Dc
Autarky
Wheat
MCc/MCw >
Pc/Pw
Dw
Sw
Dc Sc
Autarky Equilibrium
Wheat
MCc/MCw =
Pc/Pw
Dw = Sw
Dc=Sc
Lets Talk about the Supply of
Each of the Resources, T and
L
Consider the impact on the PPC
Autarky
Wheat
Location of
PPC
determined
by
amount of L
and T
L and T increase by same %
Wheat
Location of
PPC
determined
by
amount of L
and T
Suppose L grows faster than T
% increase in L > % increase
in T
Which industry expands more
rapidly?
If L grows faster than T
Wheat
Suppose W labor
intensive
If L grows faster than T
Wheat
Suppose C labor
intensive
What Happens to the autarky
Pc/Pw when a countrys T
grows faster than L?
If L grows faster than T
Wheat
Pc/Pw
Introduce Another Country
and Potential for Trade
INITIALLY
Assume identical in all respects
Same Taste Preferences
Neutralize demand influence
Wheat
Wheat
U.S.
RoW
Cloth
Cloth
Same Technology, Same
Amount of T and L
U.S. PPC
Wheat
RoW PPC
Wheat
Cloth
Cloth
Autarky When Everything
Identical
U.S. PPC
Wheat
RoW PPC
Wheat
Cloth
Cloth
Autarky When Everything
Identical
U.S. PPC
Wheat
RoW PPC
Wheat
Cloth
Cloth
Autarky When Everything
Identical
U.S. PPC
Wheat
RoW PPC
Wheat
Cloth
Cloth
Lets Allow ONLY the Relative
Supply of Resources to Differ
Requires new concept of
FACTOR ABUNDANCE
Consider implications for
shape of PPC
Factor Abundance of Nations
Nations have different relative amounts of
resources
Compare ratios of resource supplies to
determine abundance
If Tus/Lus > Trow/Lrow then U.S. is land
abundant
Example Land Abundance
UNITED STATES
50,000 acres / 25,000 hrs = 2
acres/hr
REST OF WORLD
60 mll acres/60 mll hrs = 1 acre/hr
Other Nations Abundance
If U.S. land abundant, the RoW must
be labor abundant:
Lus/Tus
<
Lrow/Trow
Hecksher-Ohlin Theory
A country will have a comparative
advantage in the product that uses
the nations abundant factor
intensively
So -- if U.S. is land abundant and
wheat is land-intensive, then it will
have a lower autarky price of wheat.
The U.S. will export wheat and import
cloth.
RoW Gets More T and L
U.S.
Wheat
RoW
Wheat
Cloth
Cloth
Row Gets More T and L
U.S.
Wheat
Pc/Pw = 2 w/c
67 w/c
Cloth
RoW
Wheat
Pc/Pw= .
Cloth
Heckscher-Ohlin Theory of Trade
A country will export products that use relatively
intensively those production factors found
relatively abundantly in the country, and import
products that use relatively intensively those
production factors that are relatively scarce in
the country.
H-O comparative advantage is actually a triple
comparison:
across countries
across products
across factors of production