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Heckscher Ohlin Model Essay

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Pip Reeve IEMT10W2T1

1. Consider a 2-good, 2-country, 2-factor world: a. Explain why the Heckscher Ohlin Theorem might fail to hold in the absence of the following assumptions: a.i. Identical production functions across countries a.ii. Identical and homothetic consumer preferences across countries a.iii. Non-reversibility of factor intensities in each industry b. Are the above assumptions required for the factor equalisation theorem? If so, why? If not, why not?
I will begin with a brief explanation of the basic results of the H-O theorem. Some of the key results of this model include the fact that two countries that share the same general technology but differ in their endowments of the basic factors of production may nonetheless find that free trade in commodities forces wage rates in the two countries into absolute equality. The pattern of trade reflects the relative endowment of productive factors - relatively labour abundant countries tend to export relatively labour intensive commodities. Also, freeing up trade benefits the relatively abundant factor of production but harms the relatively scarce factor. So, the H-O theorem can be stated as follows 'a capital abundant country will export the capital intensive good, while the labour abundant country will export the labour intensive good. If technology is flexible, the actual choice of technique depends on market values of wages and rentals on capital equipment - hence relatively high wages will encourage all sectors to adopt relatively capital intensive methods of production. So, the theorem states that relatively capital abundant counties should export relatively capital intensive commodities. But if technology is superior in one country, for a comparable relative output the relative cost of producing is lower abroad. With equal production ratios, the capital intensity of production would be greater in both industries in the capital abundant country - not necessarily the case if production functions not identical. If the assumption of identical and homothetic consumer preferences does not hold, the H-O theorem may no longer hold. For example, a strong taste bias for manufactures at home could result in the home country being a relatively expensive source of manufactures, so that with trade it imports this item (even if it has large amounts of capital). However, it is difficult to conclude how this will effect the H-O theorem. If X is intensive in labour, this means that for given factor prices X will always have an incentive to produce with a higher L/K ration than will M. Factor intensity reversibility occurs if the isoquants cross twice (as shown in Fig 3.3):

One explanation for the Leontief Paradox (US assumed to be more capital abundant but exports were more labour intensive than import substitutes) is that there were factor intensity reversals. A commodity that is produced by relatively labour intensive techniques at home may be produced by relatively capital intensive techniques abroad. This is factor intensity reversal. Johnson claims that limited international factor mobility can make the factor price equalisation theorem work even if factor intensities are reversible. The factor price equalisation theorem states that free trade that equalises commodity prices between countries sharing the same technology must equate wages and rents in the home country with those abroad if each country actively produces both commodities. With free trade at least

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