Question

Suppose we have assumptions that allow us to utilized a H-O model to analyze the implications of trade between two countries, Home and Foreign. Their pre-trade capital stock and number of workers and allocations to each industry are given in the table below

	Home		Foreign
	Widgets	Fizzy	Widgets	Fizzy
K	4 million	1 million	1.5 million	0.5 million
L	2million	8 million	1 million	2 million

Capital and labor are both mobile across industries, and are used to produce two goods widgets and fizzy. We also know that in both countries production is based on constant returns to scale technology and widget production is capital intensive and fizzy is labor intensive.

First, what is the equilibrium level of relative labor in both countries. Second, explain what will happen to the relative wage in Home if these two countries open up to trade.

Answer 1

a) From the above table,

We have Total labour availability in Home country (L₁) = 2 +8 = 10 million

Also total capital availability in Home Country (K₁) = 4+ 1 = 5 million

Total labour availability in Foreign country (L₂) = 1+2 = 3 million &

total capital availability in Foreign Country (K₂) = 1.5+ 0.5 = 2 million

Therefore, equilibrium level of relative labour in home Country = L₁ = 10 million

Also, equilibrium level of relative labour or labour to capital ratio in foreign Country = L₂ = 3 million

b) If both countries open up trade, it means relatively more capital intensive country i.e., Home will have more output of capital intensive good which is widget. Therefore, unit price of widget in Home will be comparatively low. It means

Labour to Capital ratio for Widget in Home country = 2:4 = 1:2

Labour to Capital ratio for Fizzy in Home country = 8:1

Let w = wage rate of labour and r = rate of capital in Home Country and unit price of Widget is P, then under Heckscher-Ohlin Pure profit equilibrium, we have

w +2r = P and 8w + r = 1, From these two equations we have,r = (P-w)/2-----(ii)

Also r = 1-8w ----(i)

From (i) and (ii), we have, (P-w)/2 = 1-8w or, w = (2-P)/15 which means if price of Widget will decrease, wage rate of labour will increase and if price of widget will increase, wage rate of labour will decrease.