International Trade Essay I Student ID: Name: Mark: “The Heckscher-Ohlin Model suggests that the basis of comparative advantage lies primarily in a difference in factor endowments between countries, and that if countries enter into international trade based on that comparative advantage they will be better off in real terms. ” Explain the meaning and the implications of this statement. Illustrate your answer with the appropriate diagram(s). Introduction
The Heckscher–Ohlin model (H–O model) is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo’s theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region. The model essentially says that countries will export products that utilize their abundant and cheap factor(s) of production and import products that utilize the countries’ scarce factor The 2? 2? model The original H-O model assumed that the only difference between countries was the relative abundances of labor and capital. The original Heckscher–Ohlin model contained two countries, and had two commodities that could be produced. Since there are two (homogeneous) factors of production this model is sometimes called the “2? 2? 2 model”. Assumptions of the theory The original, 2x2x2 model was derived with restrictive assumptions, partly for the sake of mathematical simplicity. Some of these have been relaxed for the sake of development.
These assumptions and developments are listed here. 1. Both countries have identical production technology 2. Production output must have constant Return to Scale 3. The technologies used to produce the two commodities differ 4. Labor mobility within countries 5. Capital mobility within countries 6. Capital immobility between countries 7. Commodities have the same price everywhere 8. Perfect internal competition Suppose there are two countries country A and country B. Country A is labor abundant; Country B is capital abundant, (SL/SK)A>(SL/SK)B (PL/PK)A < (PL/PK)B
PL=Wage, PK=Rate (w/r)A < (w/r)B Wheat is labour intensive industry and cloth is capital intensive industry Country A has comparative advantage in wheat while Country B in cloth [pic] The Country A and the Country B Production Possibility curves reflecting their relative factor abundances and the relative factor intensities of wheat and cloth production. [pic] Assuming only difference in factor supplies the resulting autarky equilibrium at point A for Country A and point X for Country B suggest autarky price ratios such that (Pw/PC)A PCB (PW/PC)A < (PW/PC)B
Comparative advantages are based solely here on differences in factor endowments between countries. [pic] Both countries’ face to same preference so indifference curve is same Two countries specialize in production and exchange in the international market place With the free trade equilibriums, both countries gain from the trade process and reach a higher satisfaction level World welfare is maximised. Conclusion Both countries gain from trade based on a comparative advantage generated from a difference in factor endowments ———————– i0 i2