ECON 371
1.Consider a Heckscher-Ohlin (H-O) model in which the two countries are the United States (USA) and China (CHN); the two factors of production are
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# 1.     Consider a Heckscher-Ohlin (H-O) model in which the two countries are the United States (USA)

and China (CHN); the two factors of production are skilled labor or "human capital" (H) and ordinary labor (L), which receive wages WH and WL; the two goods are jet airplanes (A) and electronic devices (E). You may assume that USA is skilled-labor (H) abundant.

a.      Draw the relative demand (RD) for skilled labor curves for the two goods (Hint: put relative factor supplies H/L on the horizontal axis, and the relative wage WH/WL on the vertical axis). Which one is further to the right, RD for airplanes (A) or electron­ics (E)?

i.     On a separate diagram of this type for each country, show the economy-wide average relative demand for skilled labor and indicate which way it shifts in each country as a result of trade (and briefly explain why it shifts that way). What is the predicted impact on the relative wage WH/WL in USA? in China?

b.     Which groups (L and H workers in each country) do you expect to gain and which ones to lose as a result of free trade, according to this model? To support your answer:

i.     Analyze what happens to absolute wages in terms of both goods (WH/PE, WH/PA, WL/PE, and WL/PA) using the relevant marginal productivities of skilled and unskilled labor (MPH and MPL for E and A). State which theorem you are applying here.

ii.     Also show the direction of change in the ratios in the following equation, which equates the relative supply of the factors to the relative demand:

Do the factor intensities (HE/LE) and (HA/LA) move in the same direction, or opposite directions? Explain how this is possible.

iii.     Do these gains and losses depend on which industry the workers are employed in? Do they depend on which good each type of worker consumes more of? Why or why not?

c.      Assuming that there is free trade between the USA and China what would you expect to happen to the real wages of the two factors (WH/PE, WH/PA, WL/PE, and WL/PA) in a free-trade equilibrium? Would we expected factor prices in each country to converge or diverge? What forces could prevent such an outcome from occurring?

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