Advanced International Trade Theory and Policy
Advanced International Trade Theory and Policy ECON 433
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Date Created: 11/01/15
Advanced International Trade Lecture 14 Prof Tybout October 19 2006 Lecture outline The HeckscherOhlin model with exible technologies Factor price equalization The Edgeworth box and the PPF Relevant reading Caves Frankel and Jones chapter 6 including the Appendix Note Second problem set is posted due next Tuesday Oct 24 The HO model Some key results established thus far Given world prices for Xand Y there is a unit isocost line consistent with zero profits in the production of each good Associated with this isocost line are factor prices wr and factor intensities of production kx ky If a country s aggregate capitallabor ratio k falls between kX andky it will produce both goods If 13gt ky produce only the capitalintensive good have high wr k lt kx produce only the laborintensive good have low wr An increase in the price of one good increases the price ofthe factor that is used intensively in its production Skillbiased technological change can shift factor market equilibrium in such a wa that39 The gap between skilled and unskilled wages grows Production of at least one good becomes more skillintensive 3 The HO model The Factor Price Eguaiization Fheorem If trade causes t wfries to face the same product prices 39 oduce both goods then both cou prices The HO model Factor Qrice egualization World prices determine the position of the unit revenue isoquants and the associated unit cost line This line determines the factor prices at which both goods can be produced in perfect competition When both countries have capitallabor ratios between the two rays kX and ky they will both operate on this isocost line and thus have the same factor K PYWQY1 prices Edgeworth box and PPFs Qx Xm Edgeworth box and PPFs y Qy1 OY Qy2 Qy3 7 EL Ky QyYmax 7 Edgeworth box and PPFs KX L I 0y meZ Yum2 LX 0 K s Edgeworth box and PPFs Each point in the Edgeworth box corresponds to a particular factor allocation between the two sectors and a particular level of output for each good The tangency points between the two sets of isoquants correspond to efficient allocations Why The tangency points are also profit maximizing points Why Edgeworth box and PPFs Slope wr Edgeworth box and PPFs Moving along the efficient locus from specialization in Xto specialization in Y production of both goods becomes more laborintensive Moving along the efficient locus from specialization in Xto specialization in Y the wage rate falls relative to the return on capital Edgeworth box and PPFs The PPF associated with the efficient locus is bowed outward The diagonal is associated with a straight line production possibility frontier Production along the efficient locus exceeds production along the diagona Output prices determine the production point on the PPF and thereby determine factor prices just as we have seen using Lerner diagrams Edgeworth box and PPFs Qy wr rises as PX Py rises assuming Xis laborintensive Edgeworth box and PPFs good X is relativ viy labor ads to irecrease wir Note The StolperSamuelson theorem can be demonstrated using Lerner diagrams too Edgeworth box and PPFs How do factor stocks determine the shape of the PPF the eupply quoti quot quot Li oil DOG tile my that factor iniene ve y and production of other good Edgeworth box and PPFs Expansion ofthe labor force holding factor prices fixed WW Edgeworth box and PPFs Qy As the labor force expands the PPF shifts outward dis proportionater for the labor intensive good Edgeworth box and PPFs Proportionate increases in K and L lead to proportionate increases in output of both goods Hence countries with the same KL ratio have PPFs that are identical in shape Edgeworth box and PPFs Proportionate expansion of both factors holding factor prices fixed 0 a o y AK 0y quot I K 1 Ill L AL Edgeworth box and PPFs Countries of different sizes with the same Qy KL ratio have PPFs with the same shape Edgeworth box and PPFs Combining this fact with the Qy Rybczynski theorem it follows that countries with higher KL ngh KL country ratios have steeper PPFs along any ray from the origin Low KL country Autarky equilibrium in the HO model Assume KL is higher in the home country and Y is more capitalintensive than X hom and foreign production and consumption production onsumption Trading equilibrium in the HO model Ratio of Y to X consumption in both countries 0 gn production Trading equilibrium in the HO model Because the relative price of Xfalls at home home producers shift away from Xand toward Y production Consumers shift away from Y and toward X production Or put differently home will export Y and foreign will export X All of this traces simply to differences in factor endowments The HO Theorem If Yproduotion uses capital relatively intensively and that X production uses L relatively intensively the country with the higher KL ratio will export Yand the country with the lower KL ratio will export X