Question

380 Global Economy

Consider a world comprised of a capital-abundant developed country (H) and labor-abundant developing country (F). Both countries produce perfectly competitive agriculture (A) and manufacturing (M) sectors, which are labor (L) and capital (K) intensive, respectively. Each sector uses both factors for production, and those factors are substitutable. Demand structure is the same across the countries. The amount of factor “used” for each sector is given by Aka, Ala, Akm, and Alm. For other variables needed, use superscript H and F to denote the developed and developing countries, respectively.

For the following questions, now assume that trade is opened up

. 3. Describe what happens to the relative price of agriculture in the developed country as a result of trade. Draw a relevant graph.

4. Describe the pattern of trade. Be sure to draw a relevant graph.

5. Generalize your answer to question 4. That is, summarize the prediction of the trade pattern in one sentence, which can be used in other examples of the Heckscher-Ohlin model.

6. Discuss the effect of trade on the welfares of labor and capitalists in the developed country. Specifically explain how you derived these welfare effects. Which group would support building trade barriers in this developed country?

Answer 1

Heckscher Ohlin model was developed on the basis of comparitive advantage. According to this model, a country specializes in the production of the commodity in which it has factor abundance. Trade helps in equalisation of the relative prices for the commodities in both the countries and also for achieving a higher indifference curve.