econ 390 lecture notes, Lecture notes of Economics

Download econ 390 lecture notes and more Lecture notes Economics in PDF only on Docsity!

Unit 1: Trade TheoryUnit 1: Trade Theory

Heckscher-Ohlin Model Heckscher-Ohlin Model

Heckscher-Ohlin ModelHeckscher-Ohlin Model

Trade occurs due to differences in resources. Countries have different relative abundance of factors of production. Production processes use factors of production with different relative intensity.

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-1: The Production Possibility Frontier Without Factor Substitution with more than 1 factor

• (^) OC no longer constant
• (^) PPF no longer straight line Why? PPF subject to 2 constraints: capital and labor

unit capital requirementunit capital requirement – number of units of capital required to produce a unit of product

Ricardian Model: unit labor Ricardian Model: unit labor

a KC ≡ unit capital requirement for cloth a KF ≡ unit capital requirement for food a LC ≡ unit labor requirement for cloth a LF ≡ unit labor requirement for food

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-1: The Production Possibility Frontier Without Factor Substitution The production possibilities frontier is subject to both constraints (capital & labor). Without factor substitution, the PPF is the interior of the two factor constraints.

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-1: The Production Possibility Frontier Without Factor Substitution Max food (point 1) fully uses capital with excess labor. Max cloth (point 2) fully uses labor with excess capital. Intersection of labor and capital constraints (point 3) fully uses capital and labor.

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-1: The Production Possibility Frontier Without Factor Substitution

a

KC

Q

C

+ a

KF

Q

F

≤ K

a

LC

Q

C

+ a

LF

Q

F

≤ L

PPF equations don’t allow for factor substitution (unit factor requirements are constant on constraints).

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-2: The Production Possibility Frontier with Factor Substitution Allowing factor substitution leads to a curved PPF. Opportunity cost increases continuously as producers make more cloth.

Heckscher-Ohlin: productionHeckscher-Ohlin: production

Fig. 5-3: Prices and Production

V = P

C

Q

C

+ P

F

Q

F Q C ≡ output of cloth Q F ≡ output of food P C ≡ price of cloth P F ≡ price of food V ≡ total value -P C

/P

F ≡ slope of isovalue

Fig. 5-4: Input Possibilities in Food Production

Heckscher-Ohlin: mix of inputs Heckscher-Ohlin: mix of inputs

With factor substitution producers can choose different mixes of labor and capital to produce food:

• (^) less capital & more labor; or
• (^) more capital & less labor

Fig. 5-5: Factor Prices and Input Choices Assume at any given w/r: a LC /a KC

a LF /a KF or L C

/K

C

> L

F

/K

F So cloth uses more labor relative to capital than food. Cloth is labor-intensive ; food is capital-intensive. Cloth curve right of food curve.

Heckscher-Ohlin: factor prices Heckscher-Ohlin: factor prices

Fig. 5-6: Factor Prices and Goods Prices In competitive markets, the price of a good depends on its cost of production, which depends on the price of factors.

Heckscher-Ohlin: factor prices Heckscher-Ohlin: factor prices

Fig. 5-6: Factor Prices and Goods Prices Stolper-Samuelson theorem If the relative price of a good increases, then the real wage or rental rate of the factor used intensively in the production of that good increases, while the real wage or rental rate of the other factor decreases.

Heckscher-Ohlin: factor prices Heckscher-Ohlin: factor prices

Fig. 5-7: From Goods Prices to Input Choices

Heckscher-Ohlin: factor prices Heckscher-Ohlin: factor prices

By rotating the graph in figure 5-6 it can be combined with the graph from figure 5-5 (both have w/r as the y-axis).