Question

In class, we developed a PPF for an economy that produced two goods with no factor substitution. This PPF gives some intuition for why the PPF in the the Heckscher-Ohlin Model is curved.

a. Imagine an economy makes only clothes (QC) and food (QF) and has two inputs of production: Labor (L) and Capital (K). It takes 4 units of capital and 1 unit of labor to make one unit of clothing. It takes 1 unit of capital and 1 unit of labor to make one unit of food. There is no substitutability between the two inputs. Which industry is labor intensive and which is capital intensive? Show how you know.

b. Draw the PPF for this country if it has 4,000 units of capital and 2,000 units of labor. Be sure to separately identify the labor constraint, the capital constraint and the country’s actual PPF. c. Identify on which segment of the PFF the following is true:

i. The country is using all of its L, with some K leftover.

i. The country is using all of its K, with some L leftover.

iii. The county is using all of its K and L.

d. If we weaken the assumption of no substitutability, the PPF will go from being “kinked” to being curved. Explain why it is curved and why this is different from the reason the PPF was curved in the Specific-Factors Model.

Answer 1

a. It takes 4 units of capital and 1 unit of labor to make one unit of clothing. Hence the capital labor ratio in clothing is 4/1 = 4. It takes 1 unit of capital and 1 unit of labor to make one unit of food. This gives the capital labor ratio in food = 1/1. Now we compare the capital labor ratio in two industries and see that it is higher for clothing. Hence clothing is capital intensive and so food industry is labor intensive

b. Economy has 4,000 units of capital and 2,000 units of labor. With K/L in clothing being 4, it can maximum produce 4000 units of clothing and 2000 units of food. Labor constraint is 2000 and Capital constraint is 4000.

c. We find that whether its clothing or food, ii. The country is using all of its K, with some L leftover. This happens because  it can maximum produce 4000 units of clothing (using all capital and leaving 1000 units of labor) and 2000 units of food (using all labor and capital)

d. If we weaken the assumption of no substitutability, the PPF will go from being “kinked” to being curved. From being curved it shows that the degree of substitutability is costly as more and more resources are transfered from good to another. This measures the opportunity cost of the not producing the other good. This is the reason why PPF has an increasing opportunity cost as resources are not equally skilled in both goods.