Question

Indicate whether the following statement is true/false/uncertain and explain why:

1. The Heckscher-Ohlin-Samuelson theory is likely to explain the rise of the skill premium in the US and other industrialized countries in recent decades, because in the data we have observed a rise in the price of skill-intensive goods relative to unskilled labor-intensive goods over the same period.

2. In the Melitz model if the transport cost t is zero then opening up to trade does not force the least productive firms to exit the market (compared to autarky)

3. An individual worker may be better off as a result of trade in the short run, but maybe worse off in the long run.

4. The HOS theory predicts that, if countries start trading goods, the factor prices(returns to factors, for example wages) will become more similar across countries.

Answer 1

1. True

It is true that the Heckscher-Ohlin-Samuelson theory was successful in explaining the rise in skill premium in the US and in the Industrialized countries. However it failed to explain the criteria of increasing skill premiums in relatively skill-scarce countries while it predicted just the opposite. The theory basically states that factor abundance that determines the pattern of trade rather than technology.

The rise in the skill intensive goods in the developed markets are because of the increased demand for those goods compared to the skill-unintensive goods. Also, the skill intensive markets are more productive compared to the less productive and protectionist policies of the skill-unintensive markets.

2. True

Transportation costs are a major factor in trade relations and profit generation. The lesser the transportation costs, more will be the profitability. In case of free trade between two countries, if the transportation cost is zero, it creates a single combined market and every active firm tries to export their products. It actually helps even the least profitable country to grow and exporting companies will have much more advantage if the transport cost to home country and the other country are both positive.

3. True

Short run is a period when the firms face both fixed and variable costs and they might not be in a position to adjust the wages and production. Hence it is beneficial to individual workers in the short run while in long run, the firms have the ability to adjust all sort of costs and they have the freedom to enhance the production, reduce the cost of production or wages,etc. Hence it might not be good for the individual workers as technological advancements also hinder their growth in the industry as processes gets more and more automated.

4. True

It is true that if the countries start trading goods, the factor prices will become similar. As countries will be having different market conditions, one may be a capital-intensive market while the other one may be labor-intensive.The profit-seeking companies of both markets trade their goods to those countries where there is relatively more price in the market. And as the trade increases, the price of goods in both markets will become eventually similar.