*CHAPTER 4(Core Chapter)THE HECKSCHER-OHLIN AND OTHER TRADE THEORIESOUTLINE4.1 Introduction4.2 Factor Endowments and the Heckscher-Ohlin Theory4.3 The Formal Heckscher-Ohlin ModelCase Study 4-1 The Revealed Comparative Advantage of Various Countries and Regions4.4 Factor-Price Equalization and Income DistributionCase Study 4-2 Has International Trade Increased U.S. Wage Inequalities?4.5 Empirical Tests of the Heckscher-Ohlin Theory4.6 Economies of Scale and International TradeCase Study 4-3 The New International Economies of Scale4.7 Trade Based on Product DifferentiationCase Study 4-4 Growth of Intra-Industry Trade4.8 Technological Gap and Product Cycle ModelsCase Study 4-5: The United States as the Most Competitive Economy in the World4.9 Transportation Costs and International Trade4.10 Environmental Standards and International TradeAppendix The Specific-Factors Model and Intra-Industry Trade ModelsA4.1 The Specific-Factors ModelA4.2 A Model of Intra-Industry TradeKey TermsInternationalofscaleeconomies pricesRelativefactorproducts Heckscher–Ohlin (H–O) theory DifferentiatedtradeIntra-industryHeckscher–Ohlintheorem(H–O)Factor-proportions or factor-endowment theory Technological gap modelcyclemodelProductFactor–price equalization theoremcostsTransportationStolper-Samuelsontheoremmodel Nontraded goods and services Specific-factorsparadox Environmental standardsLeontiefMonopolisticcompetitionscalereturnsIncreasingtoLecture Guide1. This is one of the most important and difficult chapters in the book. It is also a long chapter andrequires four lectures to cover adequately.2. In the first lecture, I would cover sections 1-3. Section 3 is one of the most important sections inthe book because it presents the H-O model. I would proceed slowly and carefully in explaining Figure 4.1 and compare it to the standard trade model of Figure 3.4.3. In the second lecture, I would cover sections 4 and 5. Section 4 on the factor-price equalizationtheorem and income distribution is a difficult section. Case Study 4-2 should be of great interest to the students and give rise to a great deal of class discussion.4. In third lecture, I would cover sections sections 6-7, paying a great deal of attention to section 7on trade in differentiated products.5. In fourth lecture, I would cover the rest of the chapter.Answers to Review Questions and Problems1. a. The Heckscher–Ohlin (H-0) theorem postulates that a nation will export those commodi- ties whose production requires the intensive use of the nation’s relatively abundant and cheap factor and import the commodities whose production requires the intensive useof the nation’s relatively scarce and expensive factor. In short, the relatively labor-richnation exports relatively labor-intensive commodities and imports the relativelycapital-intensive commodities.b. Heckscher and Ohlin identify the relative difference in factor endowments amongnations as the basic determinant of comparative advantage and international trade.c. The H-O Theory represent an extension of the standard trade model because it explains the basis for comparative advantage (classical economists, such as Ricardo had assumed it) and examines the effect of international trade on factor prices and income distribution (which classical economists had left unanswered).2. See Figure 1 on the next page.3. a. The factor–price equalization theorem postulates that international trade will bring about the equalization of the returns to homogeneous or identical factors across nations.b. The Stopler-Samuelson theorem postulates that free international trade reduces the realincome of the nation’s relatively scarce factor and increases the real income of the nation’s relatively abundant factor.Fig 4.1Fig 4.2XXb. The specific-factors model postulates that the opening of trade (1) benefits the specific factorused in the production of the nation’s export commodity, (2) harms the specific factor used in the production of the nation’s import-competing industry, and (3) leads to an ambiguouseffect (i.e., it may benefit or harm) the mobile factor.c. Trade acts as a substitute for the international mobility of factors of production in itseffect on factor prices. With perfect mobility, labor would migrate from the low-wagenation to the high-wage nation until wages in the two nations are equalized. Similarly,capital would move from the low-interest to the high-interest nation until the rate ofinterest was equalized in the two nations.4. a. The Leontief paradox refers to the original Leontief’s finding that U.S. import substituteswere more K-intensive than U.S. exports. This was the opposite of what the H-O theorempostulated.b. The Leontief paradox was resolved by including human capital into the calculations andexcluding industries based on natural resources. Recent research using data on many sectors, for many countries, over many years, and considering that countries could specialize in aparticular subset or group of commodities that were best suited to their specific factorendowments, provides strong support for the H-O theorem.c. The Hecksher-Olhin theory remains the centerpiece of modern trade theory for explaininginternational trade today. To be sure, there are other forces (such as economies of scale,product differentiation, and technological differences across countries) that provide additional reasons and explanations for some international trade not explained by the basic H-O model.These other trade theories complement the basic H-O model in explaining the pattern ofinternational trade in the world today.5. International trade with developing economies, especially newly industrializing economies (NIEs), contributed in two ways to increased wage inequalities between skilled and unskilled workers in the United States during the past two decades. Directly, by reducing the demand for unskilledworkers as a result of increased U.S. imports of labor-intensive manufactures and, indirectly, byspeeding up the introduction of labor-saving innovations, which further reduced the U.S.demand for unskilled workers. International trade, however, was only a small cause of increased wage inequalities in the United States. The most important cause was technological change.6. a. Economies of scale refer to the production situation where output grows proportionatelymore than the increase in inputs or factors of production. For example, output may morethan double with a doubling of inputs.b. Even if two nations were identical in every respect, there is still a basis for mutually bene-ficial trade based on economies of scale. When each nation specializes in the production of one commodity, the combined total world output of both commodities will be greater thanthan without specialization when economies of scale are present. With trade, each nationthen shares in these gains.c. The new international economies of scale refers to the increase in productivity resultingfrom firms purchasing parts and components from nations where they are made cheaperand better, and by establishing production facilities abroad-26-7. a. Product differentiation refers to products that are similar, but not identical. Intra-industrytrade refers to trade in differentiated products, as opposed to inter-industry trade incompletely different products.b. Intra-industry trade arises in order to take advantage of important economies of scale inproduction. That is, with intra-industry trade each firm or plant in industrial countries canspecialize in the production of only one, or at most a few, varieties and styles of the sameproduct rather than many different varieties and styles of a product and achieve economies of scale.c. With few varieties and styles, more specialized and faster machinery can be developedfor a continuous operation and a longer production run. The nation then imports othervarieties and styles from other nations. Intra-industry trade benefits consumers because ofthe wider range of choices (i.e., the greater variety of differentiated products) available atthe lower prices made possible by economies of scale in production.8. a. According to the technological gap model, a firm exports a new product until imitators incountries take away its market. In the meantime, the innovating firm will have introduced a new product or process.b. The criticism of the technological gap model are that it does not explain the size of techno- logical gaps and does not explore the reason for technological gaps arising in the first place, or exactly how they are eliminated over time.c. The five stages of the product cycle model are: the introduction of the product, expansion of production for export, standardization and beginning of production abroad through imitation, foreign imitators underselling the nation in third markets, and foreigners underselling theinnovating firms in their home market as well.9. See Figure 2 on page 25.10. A nation with lower environmental standards can use the environment as a resource endow-ment or as a factor of production in attracting polluting firms from abroad and achieving acomparative advantage in the production of polluting goods and services. This can lead totrade disputes with nations with more stringent environmental standards.-27-Multiple-Choice Questions1. The H-O model extends the classical trade model by:a. explaining the basis for comparative advantageb. examining the effect of trade on factor prices*c. both a and bd. neither a nor b2. A nation is said to have a relative abundance of K if it has a:a. greater absolute amount of Kb. smaller absolute amount of Lc. higher L/K ratio*d. lower price of K in relation to the price of L3. A difference in relative commodity prices between nations can be based on a difference in:a. technologyb. factor endowmentsc. tastes*d. all of the above4. In the H-O model, international trade is based mostly on a difference in:a. technology*b. factor endowmentsc. economies of scaled. tastes5. According to the H-O theory, trade reduces international differences in:a. commodity pricesb. in factor prices*c. both commodity and factor pricesd. neither relative nor absolute factor prices6. According to the Stolper-Samuelson theorem, international trade leads toa. reduction in the real income of the nation’s relatively abundant factor*b. reduction in the real income of the nation’s relatively scarce factorc. increase in the real income of the nation’s relatively scarce factord. none of the above7. Which of the following is false with regard to the specific factors theorem, international trade *a. harms the immobile factors that are specific to the nation’s export commodities or sectorsb. harms the immobile factors that are specific to the nation’s import-competing commoditiesc. has an ambiguous effect on the nation’s mobile factorsd. may benefit or harm the nation’s mobile factors8. Perfect international mobility of factors of productiona. leads to a reduction in international differences in the returns to homogenous factorsb. acts as a substitute for international trade in its effects on factor pricesc. operates on the supply of factors in affecting factor prices*d. all of the above9. The Leontief paradox refers to the empirical finding that U.S.*a. import substitutes were more K-intensive than exportsb. exports were more L-intensive than importsc. exports were more K-intensive than import substitutesd. all of the above10. From empirical studies, we conclude that the H-O theory:a. must be rejectedb. must be accepted without reservations*c. can generally be acceptedd. explains all international trade11. International trade can be based on economies of scale even if both nations have identical:a. factor endowmentsb. tastesc. technology*d. all of the above12. A great deal of international trade:a. is intra-industry tradeb. involves differentiated productsc. is based on monopolistic competition*d. all of the above13. Intra-industry trade takes place:a. because products are homogeneous*b. in order to take advantage of economies of scalec. because perfect competition is the prevalent form of market organizationd. all of the above14. Which of the following statements is true with regard to the product-cycle theory?a. it depends on differences in technological changes over time among countriesb. it depends on the opening and the closing of technological gaps among countriesc. it postulates that industrial countries export more advanced products to lessadvanced countries*d. all of the above15. Transport costs:a. increase the price in the importing countryb. reduces the price in the exporting countryc. falls less heavily on the nation with the more elastic demand and supply curves of the traded commodity*d. all of the above-30-ADDITIONAL ESSAYS AND PROBLEMS FOR PART ONE1. Assume that both the United States and Germany produce beef and computer chips with the following costs:United States Germany(dollars) (marks)Unit cost of beef (B) 2 8Unit cost of computer chips (C) 1 2(a) What is the opportunity cost of beef (B) and computer chips (C) in each country?(b) In which commodity does the United States have a comparative cost advantage?What about Germany?(c) What is the range for mutually beneficial trade between the United States and Germanyfor each computer chip traded?(b) How much would the United States and Germany gain if 1 unit of beef is exchangedfor 3 chips?Answ. (a) In the United States:the opportunity cost of one unit of beef is 2 chips;the opportunity cost of one chip is 1/2 unit of beef.In Germany:the opportunity cost of one unit of beef is 4 chips;the opportunity cost of one chip is 1/4 unit of beef.(b) The United States has a comparative cost advantage in beef with respect to Germany,while Germany has a comparative cost advantage in computer chips.(c) The range for mutually beneficial trade between the United States and Germany foreach unit of beef that the United States exports is2C < 1B < 4C(d) Both the United States and Germany would gain 1 chip for each unit of beef traded.2. Given: (1) two nations (1 and 2) which have the same technology but different factor costs conditions, and (3) no transportation costs, tariffs, or other obstructions to trade.Prove geometrically that mutually advantageous trade between the two nations is possible.Note: Your answer should show the autarky (no-trade) and free-trade points of production and consumption for each nation, the gains from trade of each nation, and express the equilibrium condition that should prevail when trade stops expanding.)Ans.: See the figure below.Fig 4.3Fig 4.4Nations 1 and 2 have different production possibilities curves and different community indifference maps. With these, they will usually end up with different relative commodity prices in autarky, thus making mutually beneficial trade possible.In the figure, Nation 1 produces and consumes at point A and Px/Py=P A in autarky, while Nation 2 produces and consumes at point A' and Px/Py=P A'. Since P A < P A', Nation 1 has a comparative advantage in X and Nation 2 in Y. Specialization in production proceeds until point B in Nation 1 and point B' in Nation 2, at which P B =P B' and the quantity supplied for export of each commodity exactly equals the quantity demanded for import.Thus, Nation 1 starts at point A in production and consumption in autarky, moves to point B in production, and by exchanging BC of X for CE of Y reaches point E in consumption. E > A since it involves more of both X and Y and lies on a higher community indifference curve.Nation 2 starts at A' in production and consumption in autarky, moves to point B' in production, and by exchanging B'C' of Y for C'E' of X reaches point E'in consumption (which exceeds A').At Px/Py=P B =P B', Nation 1 wants to export BC of X for CE of Y, while Nation 2 wants to export B'C' (=CE) of Y for C'E' (=BC) of X. Thus, P B =P B' is the equilibrium relative commodity price because it clears both (the X and Y) markets.3. (a) Identify the conditions that may give rise to trade between two nations. (b) What aresome of the assumptions on which the Heckscher-Ohlin theory is based? (c) What does this theory say about the pattern of trade and effect of trade on factor prices?Ans. (a) Trade can be based on a difference in factor endowments, technology, or tastesbetween two nations. A difference either in factor endowments or technology results in a different production possibilities frontier for each nation, which, unlessneutralized by a difference in tastes, leads to a difference in relative commodity price and mutually beneficial trade. If two nations face increasing costs and have identical production possibilities frontiers but different tastes, there will also be a differencein relative commodity prices and the basis for mutually beneficial trade between the two nations. The difference in relative commodity prices is then translated into adifference in absolute commodity prices between the two nations, which is the immediate cause of trade.(b) The Heckscher-Ohlin theory (sometimes referred to as the modern theory – asopposed to the classical theory - of international trade) assumes that nations have the same tastes, use the same technology, face constant returns to scale (i.e., a givenpercentage increase in all inputs increases output by the same percentage) but differ widely in factor endowments. It also says that in the face of identical tastes or demand conditions, this difference in factor endowments will result in a difference in relative factor prices between nations, which in turn leads to a difference in relativecommodity prices and trade. Thus, in the Heckscher-Ohlin theory, the internationaldifference in supply conditions alone determines the pattern of trade. To be noted is that the two nations need not be identical in other respects in order for internationaltrade to be based primarily on the difference in their factor endowments.(c) The Heckscher-Ohlin theorem postulates that each nation will export the commodityintensive in its relatively abundant and cheap factor and import the commodityintensive in its relatively scarce and expensive factor. As an important corollary, itadds that under highly restrictive assumptions, trade will completely eliminate thepretrade relative and absolute differences in the price of homogeneous factors amongnations. Under less restrictive and more usual conditions, however, trade will reduce, but not eliminate, the pretrade differences in relative and absolute factor prices among nations. In any event, the Heckscher-Ohlin theory does say something very useful onhow trade affects factor prices and the distribution of income in each nation. Classical economists were practically silent on this point.-33-4. Suppose that tastes change in Nation 1 (the L-abundant and L-cheap nation) so that consumers demand more of commodity X (the L-intensive commodity) and less of commodity Y (the K- intensive commodity). Suppose that Nation 1 is India, commodity X is textiles, and commodi- ty Y is food. Starting from the no-trade equilibrium position and using the Heckscher-Ohlinmodel, trace the effect of this change in tastes on India's (a) relative commodity prices anddemand for food and textiles, (b) production of both commodities and factor prices, and(c) comparative advantage and volume of trade. (d) Do you expect international trade to leadto the complete equalization of relative commodity and factor prices between India and theUnited States? Why?Ans. (a) The change in tastes can be visualized by a shift toward the textile axis in India'sindifference map in such a way that an indifference curve is tangent to the steepersegment of India's production frontier (because of increasing opportunity costs) after the increase in demand for textiles. This will cause the pretrade relative commodity price of textiles to rise in India.(b) The increase in the relative price of textiles will lead domestic producers in India toshift labor and capital from the production of food to the production of textiles. Since textiles are L-intensive in relation to food, the demand for labor and therefore the wage rate will rise in India. At the same time, as the demand for food falls, thedemand for and thus the price of capital will fall. With labor becoming relative more expensive, producers in India will substitute capital for labor in the production of both textiles and food.(c) Even with the rise in relative wages and in the relative price of textiles, India stillremains the L-abundant and low-wage nation with respect to a nation such as theUnited States. However, the pretrade difference in the relative price of textilesbetween India and the United States is now somewhat smaller than before the change in tastes in India. As a result the volume of trade required to equalize relativecommodity prices and hence factor prices is smaller than before. That is, India need now export a smaller quantity of textiles and import less food than before for therelative price of textiles in India and the United States to be equalized. Similarly, the gap between real wages and between India and the United States is now smaller and can be more quickly and easily closed (i.e., with a smaller volume of trade).(d) Since many of the assumptions required for the complete equalization of relativecommodity and factor prices do not hold in the real world, great differences can be expected and do in fact remain between real wages in India and the United States.Nevertheless, trade would tend to reduce these differences, and the H-O model does identify the forces that must be considered to analyze the effect of trade on thedifferences in the relative and absolute commodity and factor prices between Indiaand the United States.-34-5. (a) Explain why the Heckscher-Ohlin trade model needs to be extended. (b) Indicate in what important ways the Heckscher-Ohlin trade model can be extended. (c) Explain what ismeant by differentiated products and intra-industry trade.Ans. (a) The Heckscher-Ohlin trade model needs to be extended because, while generallycorrect, it fails to explain a significant portion of international trade, particularly the trade in manufactured products among industrial nations.(b) The international trade left unexplained by the basic Heckscher-Ohlin trade model canbe explained by (1) economies of scale, (2) intra-industry trade, and (3) trade based on imitation gaps and product differentiation.(c) Differentiated products refer to similar, but not identical, products (such as cars,typewriters, cigarettes, soaps, and so on) produced by the same industry or broadproduct group. Intra-industry trade refers to the international trade in differentiated products.-35-。
