Question

In the Heckscher-Ohlin model, suppose that Home is abundant in skilled labor and that the computer industry is skilled-labor intensive. Both countries, Home and Foreign have always been open to trade, but a large earthquake kills half of Foreign’s skilled and unskilled workers. Which of these variables increase or decrease as a consequence? Why? Explain.

a) Relative price of computers in Home

b) Relative price of computers in Foreign

c) Output of the computer industry in Home

d) Skill premium in Home

e) Skill premium in Foreign

f) Skilled workers’ welfare in Home

g) Unskilled workers’ welfare in Home

h) Skill intensity in Home in the computer industry

Answer 1

The classical theory of international trade says that the countries trade with each other on account of comparative cost advantage.

A country will specialise in the production of those commodities on which it has a comparative advantage over the other country.

The well known classical theory of comparative advantage explains trade between two countries on two commodities. It fails to explain how trade takes place between different countries on different commodities.

Again the classical economist asserted that it is the factor endowment that makes a difference in comparative advantage.

Later the critic argued that if a country is abundant in resources it cannot produce a commodity in comparative advantage. The relative productivity of factor that makes comparative advantage.

Following the criticism, Ricardo and other classical economists rectified their mistake by saying that it is the productive efficiency of labour alone that determines the comparative advantage.

In Heckscher Ohlin theory the difference in factor endowments and difference in factor proportion that cause for a country for comparative advantage in cost.

Heckscher ohlin theory is based on two assumptions:

1.   The different countries have different factor endowments.

2.   Different commodities require different factor proportion.

For example, if country A is rich in labour and country B is rich in capital.

For producing commodity X labour intensive technology is used and for producing commodity Y capital intensive is used.

In country A commodity X can be produced cheaply while country B can produce commodity Y at a lower cost.

In other words the production of X is cheap in country A because it is rich in labour endowment as such labour is low priced factor and capital is expensive. The proportion of labour to capital is high.

In country B commodity Y can be produced cheaply because country B is rich in capital and capital is cheap and the proportion of capital to labour is high in production process.

Thus contrary to the classical, Hecksher ohlin says that comparative advantage arise not only due to factor endowments but with the relative difference in factor price and with the proportion of abundant factor used in production.

a) Relative price of computer remain the same as the earthquake and the consequent reduction of skilled and unskilled labour can nothing to do with the computer price in home country. Because the home country is using a labour intensive technology according to Hecksher ohlin theorem.

But as a concept the availability of labour in foreign decrease as a result of earthquake. In this context the labour price in country may increase due to the shortage of labour supply. This may lead to the flight of labour from home country to foreign country which may increase the domestic wage rate and reduce the comparative advantage. But here in classical and Ohlin theory there no remarks on the international mobility of factors. Eventhough the factor mobility is available labour does not move from home to foreign country because foreign country is specializing in capital intensive goods.

b)   The relative price of computer in foreign country will not increase as the country is using capital intensive

      technology.

c)   The output of computer in home country will also be the same. There is no increase or decrease in  

      factor endowment.

            d)         SKill premium is also constant in home country.

e)   In foreign country the skill premium increases because of the fall in labour supply due to earthquake.

f) The home country has to use more welfare measures for the welfare of skilled labours in home country.

            g) The home country is abundant in skilled labors so no more

                    increase in the welfare of the unskilled labors.

h) The home country has to develop the skill of its workers so that it can reap the benefit of international

      trade more.