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International Trade

by: Dr. Janiya Bernier

International Trade ECON C181

Dr. Janiya Bernier

GPA 3.77

A. Harrison

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A. Harrison
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This 5 page Class Notes was uploaded by Dr. Janiya Bernier on Thursday October 22, 2015. The Class Notes belongs to ECON C181 at University of California - Berkeley taught by A. Harrison in Fall. Since its upload, it has received 53 views. For similar materials see /class/226705/econ-c181-university-of-california-berkeley in Economcs at University of California - Berkeley.


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Date Created: 10/22/15
Lecture 7 International Trade Econ C181 EEP C181 Hecksher Ohlin Model Long Run Model 1 Introducing The Hecksher Ohlin Model Assumptions 0 2 countries 2 sectors food clothing two inputs land and labor 2X2X2 model 0 perfect competition MRMC o perfectly competitive factor markets 0 Firms maximize profits MRMC 0 People demand both goods tastes are the same in both countries 0 Endowments of land and capital differ across countries 0 No input is fixed ie devoted to only one good Both inputs land and labor are used to produce both goods and can be quickly reallocated to either sector 0 Constant Returns to Scale CRS Production Function the same in both countries ie technology the same across countries similar to speci c factor model but opposite of Ricardian framework Qc QcLcTc where L is labor input and T is land input Qf QfLfTf where L is labor input and T is land input 11 How do pro tmaximizing rms in each inudstry decide how much labor and machinery to hire at given wages and return to capital Firms choose the combination of land and labor to use to produce food and clothing How do they choose Firms will hire workers and make investments to minimize cost So unit labor and unit land requirements are not fixed as they were in the Ricardian framework In each sector producers face tradeoffs like the one illustrated by curve H which shows alternative input combinations that can be used to produce one calorie of food A farmer can produce a calorie of food with less land if he or she uses more labor and vice versa Curve H is called an isoquant it shows all combinations of land and labor that given technology yield the same amount of output Unit land input aTF in acres per calorie Units of land used to produce one calorie of food aTF Input combinations that produce one calorie of food ISOCOSt lines II 1 II Units of labor lun39l labor 39nPUt app used to produce In hours per calorie one calorie of food 3 Which combination of land and labor the farmer chooses will depend on the relative cost of land r to labor w We can show that the slope of curve H is equal to minus the ratio of w to r wr atf acres of land used to produce one calorie of food alf hours of labor used to produce one calorie of food The cost of purchasing a given amount of labor L is wL The cost of renting a given amount of land T is rT So the total cost of producing one unit of food k is K wa1f ratf So we can rewrite atf Kr wra1f So we have a straight line with slope wr That line is called an isocost line it gives all combinations of labor and land that cost the same amount K So the producer will choose to maximize output and minimize costs leading to the tangency seen above and to the right 111 What do we mean by factor intensity The production of food is relatively landintensive if at a given wage to return to land ratio wr it is true that TfLf gt TJLc We can show graphically that the production of food is relatively more land intensive relative to clothing with the two diagrams below The diagram on the left shows two curves the CC and the FF curve They are upward sloping because they indicate that at a higher ratio of wage costs to land costs producers will use more land and less labor TL rises as wr rises The FF curve is to the right of the CC curve because at any given wr ratio food uses a higher ratio of land to labor So food is landintensive and cloth is labor intensive The diagram at right called a Lerner diagram also shows that food production is landintensive relative to cloth This diagram shows with the two curves FF and CC the combinations of inputs required to produce a dollar amount of both goods The slope is again wr As shown to produce a dollar amount of food uses a higher ratio of land to labor relative to cloth So food is landintensive and cloth is laborintensive Wagerental Land input ratio wr 00 FF slope wr CC Labor input Landlabor r Factor intensity could be de ned f3 aiiy combinations of inputs For example if our model had instead of land and labor capital and labor we could try to identify the capitalintensive versus laborintensive goods Or we could identify skilled laborintensive versus unskilledlabor intensive Below we see different factorintensities for some USproduced goods in 1994 CapitalLabor NVorker Skilled LaborUnskilled Labor Clothing 12000 2 Chemicals 200000 75 Food Processing 85000 4 IV What determines comparative advantage and the pattern of trade in this framework Consider Argentina and Mexico Let us suppose that tastes and technology are the same across Argentina and Mexico However Argentina is a relatively more landabundant country than Mexico ie TALA gt TlVlLM This implies that Mexico is relatively labor abundant The gure below shows us how differences in relative endowments affect autarky output The curve TTl shows the production possibility frontier for a country before an increase in the endowment of land At world relative prices of clothing to food of PcPf the economy initially produces at point 1 An increase in arable land say brought about by clearing of forests in Argentina leads to an outward shift in the production possibility frontier to TT2 Now the economy can produce more of both food and clothing However the frontier shifts out alot more in the direction of food than in Output of the direction of clothing that is there is f d OF a biased expansion of production possibilities This is because food in Argentina is the landintensive good In fact production of food will rise but production of cloth will actually fall with the increase in arable land slope PcPF This leads to the rst result Output of cloth 00 The Rybczynski Theorem An increase in the supply of a factor at constant output prices raises the output of the good which uses this factor relatively more intensively by an even greater proportion and actually reduces the supply of the other good Intuition The greater quantity of land facilitates the production of the relatively landintensive good food to such an extent that it makes sense to withdraw some labor from the laborintensive industry clothing and reemploy it in the production of the more capitalintensive good This helps us explain the comparative advantage of Argentina and Mexico Since Argentina has relatively more land it will produce at any level of pfpc more food and less clothing than Mexico So as in the gure below Argentina s relative supply curve for food is to the right of the Mexican relative supply curve for food Since both countries have the same tastes they have the same RD curve Thus Relative price of cloth PCPF Fi39S Pfd c Relative quantity of cloth C C 0F 0 Argentina has a comparative advantage in food Mexico has a comparative advantage in clothing HecksherOhlin Theorem A country exports the good will have a comparative advantage in the good that uses its relatively more abundant factor relatively more intensively Liberalized trade increases the relative price of the good that uses a country s relatively more abundant factor relatively more intensively c ArgentrnaAutzrllty lt c Free Trade lt 0 Mexico Autzrky V Who bene ts and who loses from trade based on endowment differences in the long run How do changes in goods prices due to trade affect wages returns to land and capital Trade between Argentina and Mexico increases the relative price of food in Argentina Let s think of this as an increase in the price of food and no change in the price of clothing What happens to wages and returns to landowners The Stolper Samuels0n Theorem Trade leads to an increase in the retunr to a country s abundant factor and a fall in the return to its scarce factor So Argentinian landowners gain with trade and labor loses Mexican labor gains with trade and landowners lose Intuition As the price of food the landintensive good increases the demand for land and labor in the food industry increases Because the production of food is relatively landintensive the food industry demands alot of capital and a little labor However the clothing industry which is laborintensive releases a little land and a lot of labor as it contracts This means the return to land has to increase by alot and the return to labor has to actually decline So liberalized trade bene ts factors used relatively intensively in the production of a good that the country exports and harms factors used relatively intensively in the production of the importcompeting good In other words trade bene ts the relatively abundant factor of production and harms the relatively scarce factor of production Question If the US s abundant factor is skilled labor and its scarce factor is unskilled labor What will it export with trade What Will happen to the returns to skilled versus unskilled labor Question If Mexico s abundant factor is unskilled labor and its scarce factor is skilled labor What will happen to inequality with increased globalization VI Does trade equalize wages returns to other factors land labor across countries even when factors cannot cross borders The answer is yes if the following conditions hold for the countries trading with each other 0 Same technology across countries 0 Prices of goods ar ethe same across countries ie free trade no trade barriers 0 Countries continue to produce both goods when they start trading This result is known as the FactorPrice equaliziation FPE theorem It claims that trade leads to equalization of returns to factors across countries So with trade wages should become equal across countries and the returns to other factors land capital as well This is a strong conclusion Whih depends on the assumptions above Intuition One can either move factors across countries to equalize returns migration capital movements OR goods which embody these factors


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