Grp04 S02 - Heckcher-ohlin Theory Qn01

Heckscher-Ohlin Theory

1 a) Show by straight lines through the origin that K/L is higher for Good Y than for Good X in both countries in the absence of trade and that K/L is higher in country 2 than in country 1 for both goods. a) In Figure 1 above, in order to produce 1 Good Y, country 1 would need 2K and 2L. For the production of 1 Good X, country would need 1K and 4L. Therefore as we can see, the slope of the ray for Good Y is 1 (2K/2L=1) while the slope of the ray for Good X is 0.25 (1K/4L=0.25). The slope of the line also measures the Capital-Labour ratio, so the Capital-Labour ratios for Good Y and Good X in country 1 are 1 and 0.25 respectively. In the case of country 2, it would need 4K and 1L to produce 1 Good Y and it would need 2K and 2L to produce 1 Good X. In view of these factors, we can derive that the slope of the ray for Good Y is 4 (4K/1L=4) while the slope of the ray for Good X is 1 (2K/2L=1). Thus, the Capital-Labour ratios for Good Y and Good X in country 2 are 4 and 1 respectively. As we compare the two charts, it is quite obvious that more resources are needed to produce Good Y in both countries since the Capital-Labour ratio of Good Y is 4 times higher than Good X

(1:0.25 in country 1 and 4:1 in country 2). We can also see that between both countries, the Capital-Labour ratio of Good Y is higher in country 2 (K/L=4 in country 2 as compared to K/L=1 in country 1). Since Good Y command a much higher Capital-Labour ratio than Good X in both countries, we can safely conclude that Good Y is K-intensive commodity and Good X is a L-intensive commodity. As country 2 utilizes much more K/L in producing both Good Y and Good X as compared to country 1, then it means that it must be relatively cheap and economical to use capital instead of labour in country 2. If capital is cheaper in country 2, it shows that country 2 is a K-abundant nation. 1 b) What happens to the slope of the lines measuring K/L of each good in country 2 if r/w rises in country 2 as a result of international trade? b) As r/w rises in country 2 as a result of international trade, it shows that the demand for capital has risen considerably and thus pushes the price of capital up. Producers will then substitute labour for capital to minimize. Assuming that to produce 1 Good Y, 3K and 1.5L are now needed thus lowering the Capital-Labour ratio to 2. To produce 1 Good X, 1K and 3L are now needed, decreasing the Capital-Labour ratio to 1/3. Therefore, the slope for both Good Y and Good X will become gentler. 1 c) What happens to the slope of the lines measuring K/L of each good in country 1 if r/w falls in country 1 as a result of international trade? c) As r/w declines in country 1 as a result of international trade, it shows that the demand for capital has decreased considerably and thus caused the price of capital to fall. Producers will then substitute capital for labour to minimize production. Assuming that

to produce 1 Good Y, 3K and 1.5L are now needed thus increasing the Capital-Labour ratio to 2. To produce 1 Good X, 1.5K and 3L are now needed, increasing the Capital-Labour ratio to 1/2. Therefore, the slope for both Good Y and Good X will become steeper. 1 d) Given the results of parts b and c, does international trade increase or reduce the difference in K/L in the production of each good in the two countries as compared to the pre-trade situation? d) From the two scenarios in b) and c), it can be seen that international trade actually reduces the difference in the production of each good in both countries especially in terms of narrowing the differences in the Capital-Labour ratios of both goods in country 1(K/L=2 after trade as compared to K/L=1 before trade for Good Y and K/L=0.5 after trade as compared to K/L=0.25 before trade for Good X) and country 2 (K/L=2 after trade as compared to K/L=4 before trade for Good Y and K/L=1/3 after trade as compared to K/L=1 before trade for Good X).