360-4 - Chapter 4 The Heckscher-Ohlin Model The classical...

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Chapter 4 – The Heckscher-Ohlin Model The classical model has several shortcomings: 1. Makes unrealistic predictions like complete specialization that are not consistent with the real-world. Complete specialization results from constant opportunity cost assumption, can be modified with increasing opportunity cost assumption. 2. Classical model doesn’t explain why differences in productivity exist. 3. Classical model doesn’t explain why most trade takes place among countries with similar levels of economic development. In the early 1900s, two Swedish economists (Heckscher and his student Ohlin) extended the classical model for international trade and developed a much richer model, the HO Model. HO Insights: a. Countries differ in their factors endowments , or factors of production: quantity and quality of labor, land, capital, machinery, and natural resources. b. Goods differ according to the factors required in production, e.g., soybeans are “land- intensive” and textiles are “labor-intensive.” c. Countries will have a comparative advantage, and will therefore produce goods, whose production requires relatively large amounts of the factors with which it is relatively well- endowed. Countries with lots of farmland will produce goods that require large amounts of land for efficient production (wheat, soybeans, corn). HO is appealing for its simplicity yet completeness, and its versatility. HO MODEL: BASIC ASSUMPTIONS Economic theory/models: a) Make assumptions, b) Solve model, c) Perform experiments. We maintain Assumptions 1-10, and drop 11 and 12 (labor only) because we add other factors (capital, machinery), and we add 5 new assumptions. 1
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Assumption 13 : 2 factors of production, L (paid wage W) and K (rental payment R). Now the ratio of K/L or L/K becomes important for trade patterns, and will change as relative factor prices change (W/R). Assumption 14 : Technology is identical in each country. For any good (T), producers in both countries have access to the same production techniques, but will vary based on factor prices (W, R) in each country. If labor is relatively cheap in A, producers will use more labor- intensive methods of production. If factor prices are the same in both countries, the same production processes (K/L) will prevail in both countries. Assumption 15 : Production of T always requires more labor per machine than S, i.e., the L/K ratio is higher for T than for S. Also, we continue to assume constant returns to scale for both goods in both countries (double inputs, double output). Producing T is more labor- intensive than S, and producing S is more capital-intensive than T, so the amount of labor per machine (L/K) is higher for T than for S (Equation a below) and the amount of capital investment per worker is higher for S than for T (Equation b).
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360-4 - Chapter 4 The Heckscher-Ohlin Model The classical...

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