What is the H-O model of trade?
Also referred to as the H-O model or 2x2x2 model, it's used to evaluate trade and, more specifically, the equilibrium of trade between two countries that have varying specialties and natural resources. 1 The model emphasizes the export of goods requiring factors of production that a country has in abundance.
What is the difference between Heckscher Ohlin and new trade theory?
Standard Heckscher–Ohlin theory assumes the same production function for all countries. This implies that all firms are identical. The theoretical consequence is that there is no room for firms in the H–O model. By contrast, the New Trade Theory emphasizes that firms are heterogeneous.
What are the two most important assumptions of the H-O model?
To be more specific, all of the assumptions of the H-O model must hold perfectly. Two of the most important of these assumptions are ‘no barriers to trade’ and ‘access to identical technology’. If workers everywhere have the same productivity, then free trade guarantees that they earn the same wage.
What is the difference between H–O and new trade theory?
The theoretical consequence is that there is no room for firms in the H–O model. By contrast, the New Trade Theory emphasizes that firms are heterogeneous.
Does everyone gain from trade in the Heckscher-Ohlin model?
Even though countries as a whole benefit from specialization and international trade, all groups in society, workers and capitalists, do not gain according to the Heckscher-Ohlin theory.
What does the Heckscher-Ohlin theory say about the benefits of trade?
The Heckscher-Ohlin theorem states that if two countries produce two goods and use two factors of production (say, labour and capital) to produce these goods, each will export the good that makes the most use of the factor that is most abundant.
What does HO theory of trade say about foreign trade?
The Heckscher-Ohlin Theorem The H-O theorem predicts the pattern of trade between countries based on the characteristics of the countries. The H-O theorem says that a capital-abundant country will export the capital-intensive good, while the labor-abundant country will export the labor-intensive good.
What is the main cause of international trade according to Heckscher-Ohlin?
Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments (i.e. differences in supplies of all factors and not only of labour efficiency) and different factor-proportions required for different commodities.
What is the gains from trade hypothesis?
In economics, gains from trade are the net benefits to economic agents from being allowed an increase in voluntary trading with each other. In technical terms, they are the increase of consumer surplus plus producer surplus from lower tariffs or otherwise liberalizing trade.
What are the benefits gains from international trade?
Lowering prices for consumers. Trade lowers domestic prices; improves resource allocation through specialization; lowers profit margins of domestic producers and increases operating efficiency of domestic firms through increased competition.
How does Heckscher-Ohlin model work?
The Heckscher-Ohlin model evaluates the equilibrium of trade between two countries that have varying specialties and natural resources. The model explains how a nation should operate and trade when resources are imbalanced throughout the world.
What is the Heckscher-Ohlin theory quizlet?
Heckscher-Ohlin (H-O) Theory. the theory that postulates that (1) a nation exports commodities intensive in its relatively abundant and cheap factor and (2) international trade brings about equalization in returns to homogeneous factors across countries.
What does the HO model predict about factor prices when trade is free?
A key point: the HO model says countries implicitly export the services of abundant factor(s) and import the services of scarce factor(s). This means that free trade generates higher demand for the abundant factor, so its price rises. And it generates lower demand for the scarce factor, so its price must fall.
What are the factors that determine gains from foreign trade?
8 Essential Factors that Determines the Gains from International...Differences in Cost Ratios: ... Reciprocal Demand: ... Level of Income: ... Terms of Trade: ... Productive Efficiency: ... Nature of Commodities Exported: ... Technological Conditions: ... Size of the Country:
What are the two components of gains from international trade?
The modern approach stresses that the introduction of international trade brings two types of gains—gain from exchange and gains from specialisation. These two gains together constitute the gains from international trade.
What are the assumptions of Ho theory of international trade?
There are six assumptions usually postulated with the Heckscher-Ohlin theory of trade: (1) no transportation costs or trade barriers (implying identical commodity prices in every country with free trade), (2) perfect competition in both commodity and factor markets, (3) all production functions are homogeneous to the ...
What is the Heckscher-Ohlin theory quizlet?
Heckscher-Ohlin (H-O) Theory. the theory that postulates that (1) a nation exports commodities intensive in its relatively abundant and cheap factor and (2) international trade brings about equalization in returns to homogeneous factors across countries.
What is the conclusion of the Heckscher-Ohlin model quizlet?
What is the conclusion of the Heckscher-Ohlin model? With two goods and two factors, each country will export the good that uses intensively the factor of production it has in abundance and will import the other good.
What is the significance of Rybczynski theorem for trade theory overall?
The Rybczynski theorem demonstrates how changes in an endowment affect the outputs of the goods when full employment is maintained. The theorem is useful in analyzing the effects of capital investment, immigration, and emigration within the context of a Heckscher-Ohlin (H-O) model.
What is the H-O theory?
And, like the Ricardian theory, the H-O theory explains the basis of trade between two countries by focusing on differences in supply conditions.
Why is the SST important?
The SST has an important practical implication. It provides some support for the cheap foreign labour argument for protection. For example, in the USA, unskilled labour has an incentive to seek protection against imports of commodities that are relatively intensive in unskilled labour in reality, relative factor prices do not respond to trade as much as the H-O model predicts’.
How does the opening of trade affect the price of food?
For example, the opening of trade increases the relative price of car (its export product) in the USA and reduces the price of food (its import item). The SST then predicts a rise in the real income of the owners of capital (the factor used intensively in producing car) and a the real income of the suppliers of labour (the factor used intensively in producing food)In the rest of the world, the real income of labour increases and that of capitalists falls.
What are the assumptions of H-O?
Two of the above assumptions are critical to the H-O explanation of the basis of trade, viz., assumption 1 (that factor endowments or availabilities differ between two countries ) and assumption 4 (commodities are always intensive in a given factor regardless of relative factor prices). These assumptions have to be discussed in further detail.
What is the strong factor abundance assumption?
Finally, we assume that the countries that are labour-abundant (i.e., that have labour force that are large relative to their capital stocks), will have low wages relative to rental payments, and vice versa for capital-abundant countries. This is known as Paul Samuelson’s strong factor abundance assumption. The implication of this assumption will be clear when we compare the physical definition of factor abundance with the price definition.
Why does a shift in relative product prices bring an even more magnified response in – actor prices?
This happens because a shift in relative product prices brings an even more magnified response in – actor prices. The factor used intensively in production in the rising-price (car) sector has its market Price (e.g., rental rate) rise even faster than the product price rise Therefore its real return (its purchasing power with respect to either product) rises. A factor used intensively in the other sector has its real purchasing price cut.
How many countries have homogeneous goods?
There are 2 countries, 2 homogeneous goods, and 2 homogeneous factors of production. The initial levels of such factors remain fixed and are assumed to be relatively different for each country.
Why is it Called 2X2X2 Model?
The reason is simple, – there are two countries. Two countries engage in trading of two goods. There are two homogeneous production factors required for the same.
What is the Heckscher Ohlin model?
The Heckscher-Ohlin model also known as The H-O model or 2X2X2 model is a theory in international trade that suggests that nations export those goods which are in abundance and which they can produce efficiently. This was developed by a Swedish economist Eli Heckscher and his student Bertil Ohlin and hence the name.
What is the basis for exporting products?
Countries export products that they are abundant of or products for which they have the material/labor in abundance and such countries have a competitive advantage for such goods including land, labor, and capital and this is the basis for this model. Not just abundance, the cost of production or procurement has to be cheaper in such countries.
What are the two factors that determine the relative factor endowment of a country?
The two countries have different relative factor endowments namely capital, land and labor. Based on the relative factor endowments, countries are classified as capital abundant, labor abundant or land abundant.
What is perfect competition?
Perfect Competition Perfect competition is a market in which there are a large number of buyers and sellers, all of whom initiate the buying and selling mechanism. Furthermore, no restrictions apply in such markets, and there is no direct competition.
What is the unrealistic assumption that identical production exits?
This model assumes that nations have the same technology being used for production undermining the effects and ignoring the technological gaps.
How many countries are there in the picture?
There are two countries in the picture. This is used to make the model plainer and simpler. There are two factors – capital and labor. There is a constraint in factors i.e., the factors are limited to the funding (endowment) of the country. Countries have similar production technology.
How are marginal productivities determined?
We know that the marginal productivities are determined exclusively by the factor intensities used in production. Because country I uses more capital per unit of labour than country II, the marginal productivity of capital at P in country I will be lower than marginal productivity of capital at P’ in country II. Factor prices are determined by marginal productivities. Prom this it follows that the price of capital will be lower in country I than in country II and that the return for labour; i.e. the wages will be higher in country I than in country II. This holds when each country produces and consumes in Isolation.
What is the Heckscher-Ohlin model?
ADVERTISEMENTS: The Heckscher-Ohlin (H-O Model) is a general equilibrium mathematical model of international trade, developed by Ell 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 ...
What is the Ricardian model of comparative advantage?
The Ricardian model of comparative advantage has trade ultimately motivated by differences in labour productivity using different technologies. Heckscher and Ohlin did not require production technology to vary between countries, so the H-O model has identical production technology everywhere. ADVERTISEMENTS:
Why does international trade occur?
The model essentially states that international trade occurs because countries differ in their relative factor endowments and commodities differ in their relative factor intensities. Relative endowments of factors of production (land, labour and capital) determine a country’s comparative advantage.
How to rank goods according to factor intensities?
Let us assume country I to be abundant in capital and country II to be abundant in labour. If we rank all goods in country I according to capital intensity used in production, then, this country will first export the most capital intensive good and then go to the second most capital intensive, and so on. Similarly, country II will export its most labour intensive first, then go on to the second most labour intensive, and so on. The ranking of goods according to factor intensities is a ranking according to comparative advantage.
Why is labor intensive goods so expensive?
Labour intensive goods, on the other hand, will be very expensive to produce since labour is scarce and its price is high. Therefore, the country will be better off importing those goods.
What is PC 11?
where PC 1 is the price of capital in country I, PL 1 is the price of labour in country I, and PC 11 and PL 11 are the prices in country II of I capital and labour , respectively. In other words, if capital is relatively cheap in country I, the country is abundant in capital, and if labour is relatively cheap in country II, country II is rich in labour. Country I will export the capital intensive good and country II will export the labour exclusive good. This is explained in the figure 3.
What is the H-O model of income?
The H-O model assumes that workers and capital are homogenous and are costlessly mobile between industries. This implies that all workers in the economy receive the same wage and all capital receives the same rent. Thus if workers benefit from trade in the H-O model, it means that all workers in both industries benefit. In contrast to the immobile factor model, one need not be affiliated with the export industry in order to benefit from trade. Similarly, if capital loses from trade, then capitalists suffer losses in both industries. One need not be affiliated with the import industry to suffer losses.
What is redistribution of income in H-O model?
The redistribution of income in the H-O model is based on which factor an individual owns, not on which industry an individual works in (as it is in the immobile factor model).
How does free trade affect wages?
If a country is abundant in capital (labor), then a movement to free trade will increase real rents (wages) and decrease real wages (rents). In other words, income is redistributed from workers (capital owners) to capital owners (workers).
Why does trade occur?
Trade occurs because of differences in endowments between countries. The United States is assumed to be capital abundant, and when free trade occurs, capitalists in the United States benefit. France is assumed to be labor abundant, and when free trade occurs, workers in France benefit. Thus, in the H-O model, a country’s relatively abundant factor ...
How to measure gains or losses to workers and capitalists?
To measure gains or losses to workers and capitalists, we must evaluate the effects of free trade on their real incomes. Increases in nominal income are not sufficient to know whether an individual is better off since the price of exportable goods will also rise when a country moves to free trade. By assessing the change in real income, we can determine how the purchasing power of workers and capitalists is affected by the move to free trade.
What does it mean when the real wage in terms of clothing and steel rises?
which means that the real wage in terms of both clothing and steel rises. And. which means that the real rent in terms of both clothing and steel falls. Thus individuals in France who receive wage income only are able to purchase more of each good in free trade relative to autarky.
What does it mean when the real rent in terms of both steel and clothing rises?
which means that the real rent in terms of both steel and clothing rises. And. which means that the real wage in terms of both steel and clothing falls. Thus individuals in the United States who receive income solely from capital are able to purchase more of each good in free trade relative to autarky.
