Question

Q1: Despite that international trade in factors of production was restricted according to Heckscher-Ohlin Model, international trade leads to a complete equalization in prices of homogenous factors of production, explain.

Q2: The increase in official reserves of the country is recorded in the Balance of Payments in the debit side of the Official Reserve Transactions account, comment.

Q3: In the free floating exchange rate system, the black market for foreign currencies disappears. Discuss the validity of this phrase, explaining the reasons.

Answer 1

1. According to Hecksher Ohlin theory, International trade leads to complete equalisation of prices of homogeneous factors of production.

This is because according to this model, trade works as a substitute of international migration.

The country which is labor adundant will specialise in commodity that is labor intensive. This will raise the demand for labor in this country. Accordingly, the wages in this country will go up. Since the demand for capital will go down in this country, its price will start declining.

On the other hand, the country which is capital abundant will specialise in capital intensive goods. This will raise the demand for capital and increase the price or rental rate of capital. Since the demand for labor will go down in this country, its price will start declining

Now, the point to be noted here is that Heckscher Ohlin theory bases the gains from trade on the endowments of countries. The countries which specialised in producing labor intensive goods did so because they had a comparative advantage in labor intensive goods due to lesser price of labor in this country.

Now, the price will keep moving till they equalise in each country and the comparative advantage of each country wipes out.

(Only 1st question with no subparts according to guidelines).