Question

You observe that knowing PM and PD, you can solve for WG and WV in a system of two equations. Which theorem is this result the punchline of? Explain the intuition of this theorem in the broader context if international trade.

Answer 1

- We believe this questions is referring to Heckscher–Ohlin Model ,also known as the factor- proportions theory , where both capital and labor are variable factors of production.

- In the model each good can be produced with varying combinations of labor and capital. According to this model, differences in the relative endowment of these factors are the source of a country’s comparative advantage. This model assumes that technology in each industry is the same among countries, but it varies between industries.

- According to the theory, a country has a comparative advantage in goods whose production is intensive in the factor with which it is relatively abundantly endowed, and would tend to specialize in and export that good.

- Capital is relatively abundant in a country if the ratio of its endowment of capital to labor is than that of its trading partner.12 This scenario means a country in which labor is relatively abundant would export relatively labor- intensive goods and import relatively capital- intensive goods.

- Because the Heckscher–Ohlin model has two factors of production, labor and capital it allows for the possibility of income redistribution through trade.

- The demand for an input is referred to as a derived demand because it is derived from the demand for the product it is used to produce.

- As a country opens up to trade, it has a favorable impact on the abundant factor, and a negative impact on the scarce factor. This result is because trade causes output prices to change; more specifically, the price of the export good increases and the price of the import good declines. These price changes affect the demand for factors used to produce the import and export goods, and hence affect the incomes received by each factor of production.