INTERNATIONAL ECONOMICS

• Heckscher-Ohlin (H-O) theory of trade patterns

  • It offers realistic predictions of how trade affects the income of groups representing different factors of production (e.g., landlords, workers)
  • Trade is almost sure to divide society into gainers from trade and losers from trade because changes in relative product prices are likely to raise the rewards of some factors and lower the rewards of others
• The Heckscher-Ohlin theory claims to provide powerful insights into the basis for trade and the effects of trade, including the gains and losses for different production factors
• The Heckscher-Ohlin approach states that trade arises from differences in the availability of factor inputs in different countries and differences in the proportions in which these factors are used in producing different products
• Opening to trade

  1. Expansion in the export-oriented sector (the one using the country's abundant factor intensively in production)

  2. Contraction in the import-competing sector (the one using the country's scarce factor intensively)
• Short-run effects of opening trade

  • Demand for factors and their incomes/returns depend on the sector they are employed in
  • Factors employed in expanding sectors gain, factors employed in declining sectors lose
• Long-run factor-price response


  • Factors move between sectors in response to differences in returns
  • Wage rates end up lower for all workers and higher for all foreign workers in the long run
  • Land rents end up higher everywhere in the US and lower in the rest of the world in the long run
• The shift toward land-intensive, labor-sparing wheat will raise rents and cut wages throughout the US in the long run
• The rise in rents and the fall in wages will continue until producers come up with more land-saving and labor-using ways of making wheat and cloth
• Stolper-Samuelson theorem


  • An event that changes product prices in a country unambiguously raises the real returns to the factor used intensively in the rising-price industry and lowers the real returns to the factor used intensively in the falling-price industry in the long run, regardless of which goods the sellers of the two factors prefer to consume
• Opening of trade increases the relative price of wheat in the US, leading to a rise in the real income of the owners of land (the factor used intensively in producing wheat) and a decline in the real income of the providers of labor (the factor used intensively in producing cloth)
• In the rest of the world, the real income of labor increases and the real income of land owners decreases
• The Stolper-Samuelson result does not depend on which goods are consumed by the households of landowners and laborers
• Marginal cost of wheat


  ar + bw
• Marginal cost of cloth


  cr + dw
• Rational


  (in classical economic theory) economic agents are able to consider the outcome of their choices and recognise the net benefits of each one
• Rational agents will select the choice which presents the highest benefits
• Rational agents


  • Consumers
  • Producers
  • Workers
  • Governments
• Consumers act rationally by


  Maximising their utility
• Producers act rationally by


  Selling goods/services in a way that maximises their profits
• Workers act rationally by


  Balancing welfare at work with consideration of both pay and benefits
• Governments act rationally by


  Placing the interests of the people they serve first in order to maximise their welfare
• Rationality in classical economic theory is a flawed assumption as people usually don't act rationally
• A firm increases advertising

  Demand curve shifts right
• Demand curve shifting right

  Increases the equilibrium price and quantity
• Marginal utility

  The additional utility (satisfaction) gained from the consumption of an additional product
• If you add up marginal utility for each unit you get total utility
• The result clashed with an intuition many economists had shared. It seemed, for instance, that if U.S. laborers spent a very large share of their incomes on cloth, they might possibly gain from free trade by having cheaper cloth. Not so, according to the theorem. Opening trade must enable one of the two factors to buy more of either good, and it will make the other factor poorer in its ability to buy either good.
• Under competition, the price of each good must equal its marginal cost

  1. Pwheat = Marginal cost of wheat = ar + bw

  2. Pcloth = Marginal cost of cloth = cr + dw
• The coefficients a, b, c, and d are physical input/output ratios. These indicate how much land (a and c) or labor (b and d) is required to produce one unit of each good.
• If the price of wheat rises 10% and the price of cloth stays the same

  The rental rate for land rises, and the wage rate falls
• A factor more closely associated with the rising-price sector will have its real return (its purchasing power with respect to either product) rise. A factor more closely associated with other sectors will have its real purchasing power cut.
• The more a factor is specialized, or concentrated, into the production of exports, the more it stands to gain from trade. Conversely, the more a factor is concentrated into the production of the importable good, the more it stands to lose from trade.
• The factor-price equalization theorem: Given certain conditions and assumptions, free trade will equalize not only commodity prices but also the prices of individual factors between the two countries, so that all laborers will earn the same wage rate and all units of land will earn the same rental return in both countries even if factors cannot migrate between countries.
• The Heckscher-Ohlin approach to trade provides important insights, in theory, about the gains from trade, the effects of trade on production and consumption, and the effects of trade on the incomes of production factors both within each country and internationally.
• The first formal efforts to test the H-O theory used the simple model of two factors of production and U.S. trade data. These tests failed to confirm the H-O theory.
• More recent tests recognize that more than two types of production factors are relevant to the H-O explanation of trade patterns.
• Factors of production

  • Physical (or nonhuman) capital
  • Highly skilled labor (professional and technical workers)
  • Unskilled labor (illiterate labor)
  • Medium-skilled labor (non-scientific skilled and semiskilled workers)
  • Arable land
  • Forest land
• The United States is relatively abundant in arable land, and tends to be a net exporter of temperate-zone agricultural products such as wheat, corn, and soybeans.
• The United States has abundant endowments of some natural resources-such as coal-and tends to be a net exporter of these resource products, while it is a net importer of many other natural resource products-such as petroleum-which are found more abundantly in some other countries.
• The United States is relatively abundant in skilled labor, including scientists and engineers employed in R&D, and tends to be a net exporter of products that are skilled-labor-intensive such as machinery, aircraft, and chemicals.