Quiz 5: Resources and Trade: the Heckscher-Ohlin Model
Production possibility curve: In case of limited resources in a country, there is always a situation of trade offs in the country, i.e. the country can produce one good more by sacrificing the produce of the another good.Opportunity cost: The opportunity cost is the benefit which is lost by the individual while choosing any other alternative. It can also be defined as the return that is foregone when option is chose over the other. This concept of opportunity cost is applicable on the individual, business or even investors. The concept of opportunity cost can be used to make an informed decision when there are various options available. The comparative advantage of the country is said to be good if the opportunity cost of producing one product in that country is more than any other country. The method to calculate the opportunity cost is: There are two good produced in a market, cloth and food. It is to be known that, the quantity of goods produced is based on the capital and labor employed. It can be expressed as follows: Here, represent the quantity of output of the cloth and food, whereas, represent the employment of capital and labor in the production of cloth and represent the employment of capital and labor in the production of food.Now, the related expressions of the two types of production can be represented as: (a)As per the example, the given information is: This shows that, one unit of cloth takes, 2 units of capital and 2 units of labor whereas, 1 unit food takes 3 units of capital and 2 unit of labor. The economy has 2000 labor units available and 3000 units of capital. Hence, the constraints will be: Now, solve these constraints to express in the terms of quantity of food produced: From the given diagram, it can be seen that, the production of both the products will be possible when the relative price of the cloth is between the opportunity cost of the cloth. The opportunity cost of the cloth is determined by the slopes of the components of the PPF, i.e. . So, it can be explained as, is the economy produces less of the cloth, it the economy will use more labor to produce more cloth, hence, making the opportunity cost of cloth as unit of food. Whereas, if the production of cloth rises, the economy will have less labor and more capital, which will raise the opportunity cost of cloth to 2 units of food.This shows that, till the relative price of the cloth lies between , the economy will produce both the goods. As soon as the price of the cloth falls below , the economy will produce more food than cloth and if the price of the cloth rises above 2, then the economy will produce more cloth than food. Hence, the range of cloth is . (b)The input requirement of each good is: In the given situation, it states that, the price of one machine hour and one work hour are equal to price of cloth and food, So, Now, solve the equations for , Substitute the value of in other equation, Solve further, then, (c)The factors prices are , If there is a increase in the price of the cloth, it will impact the prices of the above factors. The price of the factors will increase and decrease with the increase in the price of cloth. The price of will fall and the price of will rise. So, it can be said that the rate of use of machine will lose and the rate of work hour will rise, because, cloth is labor intensive product. An increase in the price of the cloth will lead to increase in demand, thus leading to more production and using of more factor that it uses intensively, which is labor. (d)In the given case, the capital is increased from 3000 to 4000, and the labor constraint is kept same. If the maximum price of the cloth is kept at 2 units of food, then the new constraint will be: Solve the equation to find the value of , This shows that the minimum price of the cloth is also not changed i.e. . The new production possibility frontier will have a bigger intercept horizontally, as compared to earlier. The new production possibility frontier will now intercept the horizontal axis at . (e)The production of goods will depend on the prices of the cloth and food. So, it can be assumed, that the economy is producing at a point where it is utilizing all its resources effectively and efficiently. Now, evaluate the new constraints, Equate the two constraints, Now, substitute the value of in the equation of , So, the quantity of cloth produced by the economy will be and quantity of food will be (f)As it can be seen, in the previous part, before increase in capital, the economy produced 750 units of cloth and 500 units of food, but after increase in capital stock, the units of cloth got decreased to 500 and the units of food got increased to 1000. This is due to the effect of allocation of machine hours and work hours in the two sectors.
Cattle raising in nation-US is land-intensive as the ratio of land to labor used in cattle raising is higher than that of land to labor ratio in wheat growing. But this is not same for all the nations in the world. Every country differs in factor endowments and their relative factor prices. Nation-US have abundant land and moreover, have low density of population which makes land cheaper comparative to the other factor of production labor. So, it is worthwhile to say that cattle rising are land intensive in nation-US compared to its wheat production. But countries where less of land is used and more of labor for cattle rearing compared to that used in wheat production in nation-US, it is ambiguous to say whether cattle rearing is land intensive or not. When the land labor ratio is more in cattle rearing than in wheat production in the country, the cattle rising is land intensive in that country also.
Theories like Heckscher-Ohlin theory of international trade can assert that relative factor abundance will determine a country's export. It is not necessary that for a country to be competitive, it has to be abundant in all the resources. There are countries which lack in natural resources, capital accumulation, and innovation and even in physical labor. But these countries can still gain from trade as the question of concern is not absolute abundance of resources but the relative abundance. Poor countries have relatively more labor to capital compared to the developing and developed countries and can enjoy comparative advantage in labor-intensive goods. Thus, comparative advantage make trade possible for those countries who doesn't have absolute advantage in any good.