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CHAPTER 4. HECKCHER-OHLIN Introduction: Classical theory has a number of serious defects (e.g. complete specialization, effects of more dissimilarity on greater gains from trade). This motivated economists to come up with a new theory. At first, economists relaxed some of the restrictive assumptions of the classical model. They replaced constant opportunity cost (straight line PPF) that gives incomplete specialization with increasing opportunity cost (concave PPF) that leads to incomplete specialization. Under constant opportunity cost , when trade is allowed the relative price after specialization may rise without any change in the constant opportunity cost, leading to positive profit in one good and complete specialization in that good. In the case of rising opportunity cost, specialization according to comparative advantage will increase both the price and the cost, and at one point before production reaches the axis cost exceeds price, leading to incomplete specialization (see Figure below) Graph This modification removed the result that countries will have complete specialization. Thus, production after specializations stops before the axes. The problems with the classical theory remained still: i. International trade is based on differences in productivity . ii. The dissimilarity results and the greatest gains contradict the real world. In the real world, most of the developed countries trade with other developed countries that are similar in terms of industrial structure, per capita income, and government policies…etc. This does not support the dissimilarity result. Heckscher- Ohlin came up with a new theory. They abandoned the classical theory altogether. The HO Model Introduction :
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The HO model is based around two basic characteristics of countries: -- differences in production processes for the goods produced -- differences in factor or resource endowments Countries will be able to produce products at lower cost (i.e., have a comparative advantage in those products) if they produce the products whose production process uses intensively the abundant factor of production The model was very appealing to many economists. It is simple, logical, and capable of providing insights into many issues: effect of trade on wages; impact of economic growth on the pattern of international trade, effect of trade on income distribution …etc Assumptions: Retain the first 10 assumptions. Drop : A-11 ( labor is the only factor of production ) A-12 ( each economy has a fixed Input/ Output technology or straight line PPF ). A-11 and A-12 pertain to the classical model and give rise to straight-line PPFs. Instead, we add 5 new assumptions. A.13: Two relevant factors of production: L= Labor -> Paid W = Wage Rate K= Capital -> Paid R = Rental Rate of capital. A-14
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This note was uploaded on 04/03/2012 for the course ECON 300 taught by Professor Gang during the Fall '06 term at Rutgers.

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