1.1_Trade theory and policy and application.ppt

good one

1. Globalization and Business
Trade theories and policies

2. 09/04/24
Introduction
Heckscher-Ohlin Theorem
Leontief paradox
Lecture outline
Slide 4-2

3. 09/04/24
Introduction
In the real world, while trade is partly explained by
differences in labor productivity, it also reflects
differences in countries’ resources.
Comparative advantage is influenced by:
–Relative factor abundance (refers to countries)
–Relative factor intensity (refers to goods)
Slide 4-3

4. 09/04/24
–In a world of two goods (cloth and food) and two
factors (labor and land), food production is land-
intensive, if at any given wage-rental ratio the land-
labor ratio used in the production of food is greater than
that used in the production of cloth:
T
F/L
F > T
C/ L
C
–Example: If food production uses 80 workers and
200 acres, while cloth production uses 20 workers
and 20 acres, then food production is land-intensive
and cloth production is labor-intensive.
Factor Intensity
Slide 4-4

5. 09/04/24
–Nation 1 is labor-abundant compared to Nation 2 (and
Nation 2 is capital-abundant compared to Nation 1) if
and only if the ratio of the total amount of labor to the
total amount of capital available in Nation 1 is greater
than that in Nation 2:
L/K > L
*
/ K
*
–Example: if Nation 1 has 20 million workers and 20 million
unit capital while, Nation 2 has 80 million workers and 200
million unit capital, then Nation 1 is labor-abundant and
Nation 2 is capital-abundant.
–In this case, the scarce factor in Nation 1 is capital and
in Nation 2 is labor.
Factor Abundance
Slide 4-5

6. 09/04/24
A country will export that commodity which uses
intensively its abundant factor and import that commodity
which uses intensively its scarce factor.
The relatively labor-rich nation exports the relatively labor-
intensive commodity and imports the relatively capital-
intensive commodity.
This means that Nation 1 exports X because X is the L-
intensive commodity and L is relatively abundant and cheap
factor in Nation 1.
Nation 2 exports Y because Y is the K-intensive commodity
and K is relatively abundant and cheap factor in Nation 2.
Heckscher-Ohlin Theorem
Slide 4-6

7. Assumptions of Heckscher-Ohlin Theorem
Assumptions of the Heckscher-Ohlin model:
•There are two countries (Home and Foreign) that have:
–Same tastes
–Same technology
–Different resources
–Nation 1 (home country) has a higher ratio of labor
to capital than Nation 2(foreign country) does
•Each country has the same production structure of a
two-factor economy.

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Trade and the Distribution of Income
•Trade produces a convergence of relative prices.
•Changes in relative prices have strong effects on the
relative earnings of labor and land in both countries:
–In Home, where the relative price of cloth rises:
–Laborers are made better off and capital owners are made
worse off.
–In Foreign, where the relative price of cloth falls, the
opposite happens:
–Laborers are made worse off and capital owners are made
better off.
•Owners of a country’s abundant factors gain from
trade, but owners of a country’s scarce factors lose.
Heckscher-Ohlin Theorem
Slide 4-8

9. Illustration of the Heckscher-Ohlin Theory
Since the two nations have equal tastes, they face the
same indifference map.
Indifference curve 1 is the highest IC that Nation 1 and
Nation 2 can reach in isolation, and points A and A
/

represent their equilibrium points of production and
consumption in the absence of trade.
The tangency of IC 1 at points A and A
/
defines the
no-trade equilibrium relative commodity prices of P
A in
Nation 1 and P
A/ in Nation 2.
Since P
A
< P
A/
, Nation 1 has a comparative advantage
in X and Nation 2 has a com. adv. in Y.

10. FIGURE 6

The Heckscher-Ohlin Model.

11. Heckscher-Ohlin Theory
The right panel shows that with trade Nation 1
specializes in X and Nation 2 in Y.
Specialization continues until Nation 1 reaches point B
and Nation 2 at B
/
, where the transformation curves are
tangent to the common relative price line P
B.
Nation 1 exports X in exchange for Y and consume at
point E on IC II. Nation 2 exports Y for X and
consume at point E
/
(which coincides with point E).
Note that Nation 1’s exports of X equal Nation 2’s
imports of X (i.e. BC=C
/
E
/
).
Similarly, Nation 2’s exports of Y equal Nation 1’s
imports of Y (i.e. B
/
C
/
=C

E).

12. At P
X/P
Y > P
B, Nation 1 want to export more of X than
Nation 2 wants to import at this high relative price,
and P
X/P
Y falls towards P
B.
At P
X/P
Y < P
B, Nation 1 want to export less of X than
Nation 2 wants to import at this low relative price,
and P
X/P
Y rises towards P
B.
Point E involves more of Y but less of X than point A
However, Nation 1 gains from trade because E is on
higher IC II.
Similarly, at E
/
which involves more X but less Y than
A
/
, Nation 2 is better of because E
/
is on higher IC II.

13. 09/04/24
Testing the Heckscher-Ohlin Model
•Tests on U.S. Data
–Leontief paradox
–Leontief found that U.S. exports were less capital-intensive than
U.S. imports, even though the U.S. is the most capital-abundant
country in the world.
•Tests on Global Data
–A study by Bowen, Leamer, and Sveikauskas tested the
Heckscher-Ohlin model using data for a large number of
countries.
–This study confirms the Leontief paradox on a broader level.
Empirical Evidence on the
Heckscher-Ohlin Model
Slide 4-13

14. 09/04/24
Table 4-3: Factor Content of U.S. Exports and Imports for 1962
Empirical Evidence on the
Heckscher-Ohlin Model
Slide 4-14

15. Thank You so much
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