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Chapter_3_The_Heckscher-Ohlin_Model

12 no trade equilibrium we are going to use the

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No-Trade Equilibrium We are going to use the differences in resources to predict the pattern of trade. We begin by looking at the equilibrium that exists in each country without trade. Production Possibility Frontiers The US is capital abundant and aircraft production is capital intensive. Thus, the US is capable of producing more aircrafts than shoes. China is labor abundant and shoe production is labor-intensive. Thus, China is capable of producing more shoes. 13
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No-Trade Equilibrium Production Possibility Frontiers (PPF) for the US and China given factor abundances a) The US b) China Q of aircrafts, QA Q of shoes, QS Q of aircrafts, QA Q of shoes, Qs 14
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No-Trade Equilibrium Indifference Curves Consumer tastes are the same across countries, so the shape of the indifference curves is the same in each country. The tangencies with the two countries’ PPFs are different because of the different shapes of the PPFs. The slope at tangency equals the relative price of aircrafts—the steeper the slope, the higher the relative price of aircrafts. 15
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No-Trade Equilibrium The slope of the price line is flatter in the US than in China. The no-trade relative price of aircrafts is lower in the US than in China. a) The US b) China Q of aircrafts, QA Q of shoes, QS Q of aircrafts, QA Q of shoe, QS U PPF Relative Price of Aircrafts, slope = - (PA/PS)A A U* A* Relative Price of Aircrafts, slope = - (P*A/P*S)A* PPF* 16
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Comparative Advantage The US: The US has abundant capital. The production of aircrafts is capital intensive. The no-trade relative price of aircrafts is lower in the US. China: China has abundant labor. The production of shoes is labor intensive. The no-trade relative price of shoes is lower in China. The US has the comparative advantage in producing aircrafts and China has the comparative advantage in producing shoes. 17
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Free-trade Equilibrium in the US Under free trade, we expect the equilibrium relative price of aircrafts to rise above the no- trade relative price of aircrafts in the US. The US production moves from point A to point B based on the new relative price of aircrafts (see the diagram in the next slide). The US will produce more aircrafts and fewer shoes. The US specializes further in aircrafts and exports aircrafts. 18
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Free-trade Equilibrium in the US Because the after-trade equilibrium relative price of aircrafts increases above the no-trade relative price of aircrafts in the US, the US production moves from point A to point B after trade. That is, the US produces more aircrafts and fewer shoes after trade. a) The US Q of aircrafts, QA Q of shoes, QS PPF Relative Price of Aircrafts, slope = - (PA/PS)B A B 19
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Free-trade Equilibrium in the US Point A is the no-trade equilibrium. Without trade, both production and consumption occurs at point A.
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