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Christian Dippel
University of Toronto
Summer 2009
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 1 / 103
The Heckscher-Ohlin Model Model Set-Up
Difference To Ricardo
I In Ricardo:
I everyone wins from Trade.
I there is only one factor of production
I outcome is complete specialization
I This is very simplistic
I The Heckscher-Ohlin model aims to remedy some of these
shortcomings.
I It is more complex than Ricardo but gives far more subtle and
nuanced predictions.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 2 / 103
The Heckscher-Ohlin Model Model Set-Up
Framework
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 3 / 103
The Heckscher-Ohlin Model Model Set-Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 4 / 103
The Heckscher-Ohlin Model Model Set-Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 5 / 103
The Heckscher-Ohlin Model Model Set-Up
Set-Up Again
1. Two countries.
2. Two goods.
3. Two productive factors
I Because of (1)-(3), this is referred to as the 2x2x2 model.
4. Constant returns to scale
5. Perfect competition (all agents are price takers).
6. Countries differ only in terms of their (relative) factor endowments.
7. Factors are immobile across countries but mobile across sectors.
8. Identical Homothetic Preferences
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 6 / 103
The Heckscher-Ohlin Model Model Set-Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 7 / 103
The Heckscher-Ohlin Model Model Set-Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 8 / 103
The Heckscher-Ohlin Model Model Set-Up
We consider a small open economy where prices are exogenously given and
predict:
1. What happens to equilibrium relative factor prices and factor demand
if goods prices change (can be interpreted as movement from autarky
to free trade).
I Stolper-Samuelson Theorem and Jones Magnification.
2. What happens to equilibrium relative factor prices and the production
structure (sectorial composition) if the distribution of productive
factors changes (can interpret as immigration).
I Factor Price Insensitivity and Rybczynski Theorem.
3. Who specializes in what:
I Heckscher-Ohlin Theorem
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 9 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 10 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 11 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
I Some iso-value schedules where px,3 < px,2 < px,1 ... (at a lower
price, firm needs more inputs to yield $1 of input)
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 12 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
I The iso-cost curve gives combinations of capital and labor that (as a
bundle) cost $1. Values of w and r are taken as given. It is derived
from the following equation
wL + rK = 1
1 w
K= r − r L
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 13 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 14 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 15 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
With zero profits, both revenue and costs are equal to 1. Therefore, K and
L must lie on both curves.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 16 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 17 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
I Value of output is $1 and costs are less than $1. Positive profits (firm
entry). Not an equilibrium.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 18 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 19 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 20 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
I Value of output is $1 and costs are more than $1. Negative profits
and firm exit. Not an equilibrium.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 21 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 22 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 23 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 24 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
I Now, there are profit opportunities in the textile sector because costs
are unchanged but revenue has increased.
I Capital and labor flow into the textile sector.
I Because textiles are relatively labor intensive (flatter OEP), labor’s
wage is bid up more than capital’s rental rate.
I (w /r ) rises in response to pT /pc increasing.
I Importantly, r actually falls in this case to allow for non-negative
profits in the Computer-sector
I Intuition: for every unit of labor that shifts from the Computer to
Textile-sector, Computer-firms want to free up more capital than
textile-firms are demanding.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 25 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 26 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 27 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 28 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
restructuring if w /r increases
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 29 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 30 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
w = px mpl(K , L) r = px mpk(K , L)
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 31 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
w ∂ wr
= f (K /L) , = f 0 (K /L) > 0
r ∂(K /L)
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 32 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Example: Suppose that computers are capital intensive and textiles are
labor intensive with Cobb-Douglas production functions.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 33 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
w KT w 1 KC
Dividing (1)/(2) and (3)/(4) gives us: r = 2 LT r = 2 LC
pT KT −1/3 KC 2/3
Setting (1)=(3) (or (2)=(4)) gives us: pC 2 = ( LT ) ( LC )
Combining these expressions gives us a solution for w/r (as a function of
pT 1/3 which we can plug back in to solve for
prices): pC = (w /r )
{KC , KT , LC , LT }
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 34 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 35 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 36 / 103
The Heckscher-Ohlin Model General Equilibrium in a Small Open Economy
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 37 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 38 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 39 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
pT
Figure: The Price of Textiles Rises Relative to the Price of Computers pC ↑
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 40 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
pT
Figure: The Price of Textiles Falls Relative to the Price of Computers pC ↓
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 41 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 42 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 43 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 44 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 45 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 46 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 47 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 48 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 49 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 50 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
I Remember from the “relative prices graph” that we know the ratio of
K to L in each sector.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 51 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
I For given factor and goods prices, the Lerner Diagram gives us the
ratio of K to L (slope of OEP) in each sector.
I We can use this information in the Edgeworth Box.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 52 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
I Combinations of capital and labor in each sector must lie on the rays
below:
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 53 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 54 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 55 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 56 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 57 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
I Notice that the OEP’s did not change slope as we expanded the
Edgeworth Box. This means that w/r did not change and this
irresponsiveness of w/r with respect to changes in factor endowments
is referred to as Factor Price Insensitivity (FPI) .
I When does it hold? Intuitively, w/r cannot change in the Lerner
diagram because goods prices are exogenously given to a SOE.
I The only way w/r can change is if the country specializes in only one
good.
I This implies that the condition for FPI is that both countries are
diversified (produce both goods).
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 58 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 59 / 103
The Heckscher-Ohlin Model Stolper Samuelson and Rybczynski Theorems
Recap
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 60 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I Unlike the Ricardian model, the PPF in the HO model is bowed out
to reflect imperfect substitutability across sectors...
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 61 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
V = pC QC + pT QT
We can also think of this as an isovalue line that keeps the value of
production constant while varying the composition of production. Utility
will be maximized when the value of production is maximized and this
curve is as far up and to the right as possible.
Do not confuse this isovalue line with the isovalue curve in the Lerner
diagram.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 62 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 63 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 64 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 65 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I This also gives us a relative supply curve for the two goods
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 66 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 67 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I The relative supply (RS) curve comes from the PPF and the iso-value
lines.
I The relative demand (RD) curve comes from utility maximization as
in the Ricardian model.
I Two countries in autarky:
I Because preferences are identical and homothetic, the relative
demand curve is the same in both countries in autarky.
I Using the Rybczynski theorem, we know that the relative supply curve
for the North is to the left of the relative supply curve for the South
in autarky. To see this:..
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 68 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 69 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 70 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I With free trade and perfect competition, relative prices equate across
countries. The relative price of a given good will rise in one country
and fall in the other.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 71 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I For a given good, there will be excess relative supply in one country
and excess relative demand in the other country. This good will be
exported by the first country and imported by the other.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 72 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
I We can use the PPF graph to present the same information and to
illustrate the gains from trade.
I The following equation presents a country’s balanced trade condition:
PC CC + PT CT = PC QC + PT QT
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 73 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 74 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 75 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 76 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 77 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 78 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 79 / 103
The Heckscher-Ohlin Model Heckscher Ohlin
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 80 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 81 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 82 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 83 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 84 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 85 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 86 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 87 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 88 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 89 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 90 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 91 / 103
The Heckscher-Ohlin Model Factor Price Equalization
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 92 / 103
The Heckscher-Ohlin Model Factor Price Equalization
I The North runs out of labor and the South runs out of capital
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 93 / 103
The Heckscher-Ohlin Model Volume of Trade
Volume of Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 94 / 103
The Heckscher-Ohlin Model Volume of Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 95 / 103
The Heckscher-Ohlin Model Volume of Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 96 / 103
The Heckscher-Ohlin Model Size and Gains from Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 97 / 103
The Heckscher-Ohlin Model Size and Gains from Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 98 / 103
The Heckscher-Ohlin Model Size and Gains from Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 99 / 103
The Heckscher-Ohlin Model Size and Gains from Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 100 / 103
The Heckscher-Ohlin Model Size and Gains from Trade
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 101 / 103
The Heckscher-Ohlin Model Wrapping Up
Wrapping Up
I Unlike the Ricardian model, there are winners and losers from trade
liberalization.
I Owners of the scare factor lose because they become relatively less
scarce.
I Owners of the abundant factor win because they become relatively
more scarce.
I Winners win by more than the losers lose due to the gains from
specialization.
I In order for “everyone” to gain from trade, we must see transfer
payments from the owners of the relatively abundant factor to the
owners of the relatively scarce factor.
I Aggregate gains from trade come from the fact that consumers can
attain a higher indifference curve.
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 102 / 103
The Heckscher-Ohlin Model Wrapping Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 103 / 103
The Heckscher-Ohlin Model Wrapping Up
Christian Dippel (University of Toronto) ECO364 - International Trade Summer 2009 104 / 103