Question

The Heckscher-Ohlin model is often used to understand the long-term effects of international trade on the income distribution. Imagine a simple economy where there are only carpenters and electricians working. They produce two goods: furniture and lamps. Both types of workers are needed in the production of both goods but the furniture industry uses carpenters intensively and the lamp industry uses electricians intensively. There are two countries: the Lowlands and the Highlands. In the Lowlands there are many more carpenters per electrician compared with in the Highlands. Use the Heckscher Ohlin model to answer the following questions.

a) Suppose that there is no trade. Describe how the relative wages of carpenters and electricians are determined in the two countries. In which country is the relative wage of carpenters the highest? Explain your answer. (7.5 points)

b) Describe how the relative goods prices of furniture and lamps are determined. Where are lamps relatively more expensive? Explain your answer. (7.5 points)

c) Now assume that the two countries can trade. If we focus on the Highlands: how do relative wages of carpenters and electricians change? Who benefits in real terms and who loses? Explain your answer. (10 points)

Could you solve the problem by using graphs also. Thank you.

Andrew Jim Moore

Answer 1

The effects are shown in single disgram below:

a) In the absance of trade, cost of producing goods depends on the factor prices. Low land uses carpenter more intensively in furniture production and highland uses electrician more intensively for the production of lamp. Therefore, according to Heckscher Ohlin model, if any sector using an input intensively in producing any good, then the input price rise will affect the factor price used by that sector. Therefore, by this rule, relatice price of carpenter (Wc/We) is higher in low land and relative price of electrician is higher in highland.

b) Above disgram also shows how relatice price of furniture is determined. The process is same for the relative price of electrician determination. When relative price of carpenture rises, correspondingly relatice price of furniture also rises as furniture production uses carpenter more intensively in the low land. The logic is applicable for the relative price of lamp.

c) International trade leads to convergence of he relative prices in two countries.