International Economics Study Set 8

Quiz 4 :Resources and Trade: the Heckscher-Ohlin Model

Go back to the numerical example with no factor substitution that leads to the production possibility frontier in Figure. a. What is the range for the relative price of cloth such that the economy produces both cloth and food? Which good is produced if the relative price is outside of this range? For parts (b) through (f), assume the price range is such that both goods are produced. b. Write down the unit cost of producing one yard of cloth and one calorie of food as a function of the price of one machine-hour, r , and one work-hour, w. In a competitive market, those costs will be equal to the prices of cloth and food. Solve for the factor prices r and w. c. What happens to those factor prices when the price of cloth rises? Who gains and who loses from this change in the price of cloth? Why? Do those changes conform to the changes described for the case with factor substitution? d. Now assume the economy's supply of machine-hours increases from 3,000 to 4,000. Derive the new production possibility frontier. e. How much cloth and food will the economy produce after this increase in its capital supply? f. Describe how the allocation of machine-hours and work-hours between the cloth and food sectors changes. Do those changes conform with the changes described for the case with factor substitution? Figure The Production Possibility Frontier Without Factor Substitution: Numerical Example If capital cannot be substituted for labor or vice versa, the production possibility frontier in the factor-proportions model would be defined by two resource constraints: The economy can't use more than the available supply of labor (2,000 work-hours) or capital (3,000 machine-hours). So the production possibility frontier is defined by the red line in this figure. At point 1, the economy specializes in food production, and not all available work-hours are employed. At point 2, the economy specializes in cloth, and not all available machine-hours are employed. At production point 3, the economy employs all of its labor and capital resources. The important feature of the production possibility frontier is that the opportunity cost of cloth in terms of food isn't constant: It rises from ? to 2 when the economy's mix of production shifts toward cloth.
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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.

In the United States, where land is cheap, the ratio of land to labor used in cattle raising is higher than that of land used in wheat growing. But in more crowded countries, where land is expensive and labor is cheap, it is common to raise cows by using less land and more labor than Americans use to grow wheat. Can we still say that raising cattle is land-intensive compared with farming wheat? Why or why not?
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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.

"The world's poorest countries cannot find anything to export. There is no resource that is abundant-certainly not capital or land, and in small poor nations not even labor is abundant." Discuss.
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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.

The U.S. labor movement-which mostly represents blue-collar workers rather than professionals and highly educated workers-has traditionally favored limits on imports from less-affluent countries. Is this a shortsighted policy or a rational one in view of the interests of union members? How does the answer depend on the model of trade?
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