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The Heckscher-Ohlin Model

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The Heckscher-Ohlin model (HO) shows how trade occurs between two countries that have different resources. It assumes that the two countries have the same technologies but have uneven distribution of resources. This model is a long run model since all factors of production are able to move between industries. It has a few generations such as;

  • Different productivities
  • There are many factors of production
  • It involves two different countries; the home country and a foreign country
  • There are only two goods that are being used
  • Two factors of production are involved, mostly, Labor(L) and capital(K)

Hence Heckscher- Ohlin theorem states; with two goods and two factors, each country ill export that uses intensively the factor of production it has in abundance and will import the other good. The Stolper Samuelson theorem demonstrates how changes in output prices affect the prices of the factors when positive production and zero economic profit are maintained in each industry. It helps to analyze the effects on factor income when countries move to a free trade or when tariffs are imposed within the context of an H-O model. It has an assumption of perfect competition in all the involved markets, if there is production in a given industry, the economic profit is driven to zero. The zero profit conditions apply in each industry, (Helpman, E. 1981):

To explain the magnification effect we use a numerical example;

Suppose we have the following data;

Pc = the price of computers = 120

Pm=   the price of mobile phones= 40

L c =unit labor of computer = 3        

Kc = unit capital of computers = 4 Km =unit capital of mobile phones = 1

Lm = unit labor of mobile phones= 2

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From the above it means that computers are more capital intensive and mobile phones are labor intensive. When trade opens, the relative prices of computers increase while prices of mobile phones remain the same. If there is an increase in prices of computer, there will be a fall on wages while real rental increases. This is the magnification effect; it shows how the changes in the prices of goods have magnified effects on the earning factors. It is evident from the above that magnification effect helps us to show that even modest fluctuations in the relative prices of goods on world markets can lead to highly exaggerated changes in the long run earnings of both factors. The magnification effect relates to the Stolper Samuelsson theorem in that it ranks the percentage changes in output prices and the percentage changes in the factor prices and the magnification effect is initiated by changes in output prices. In the Solper Samuelson model, the magnification effect works under assumptions that there are fixed factors of production and for a particular set of parameters.

Preferential Trade Agreements always referred to as PTAs are pacts that are made between countries or many other countries that provide preferential treatment of bilateral trade of the countries that are involved in the agreement. Preferences are however restricted and does not involve all trade. Some common forms of PTAs include customs union and the free trade areas. The PTAs some include members of a specific geographic region such as the European Union and the North American Free Trade Area (NAFTA.) custom unions require that the countries involved maintain a common external trade policy and have free trade amongst them. Originally, there existed barriers in international trade but with the removal of such barriers there developed customs unions.

In my opinion, bilateralism is good since it enables the conclusion and design of regimes according to the needs and interests of the state. It allows government to choose the type of agreements they want and the partners they are willing to make such agreements with. This way, they make agreements that best suits their needs. It takes decisions that are made by a government of a certain country to its citizens, where the actions are best designed to meet the needs of the constituents of the country making that decision.  In addition, when bilateralism exists, a state is able to negotiate an agreement with other states. The agreement will come to full term when the state is convinced that the advantages it will obtain are fully achieved. Lastly, bilateralism allows agreement between the two countries to be concluded as easy as possible.

The Rybczynski theorem of factor accumulation

The Rybczynski theorem describes how changes in an endowment affect the output of the goods when full employment is maintained. It is useful in analyzing the effects of immigration, capital investment and emigration.

Suppose production occurs at point A, and there is an increase in labor endowment, there will be an outward shift in the labor constraint. Production will therefore shift to point B. Production of computers, the labor intensive good will rise to C1 to C2. Production of the capital intensive good will fall.

This theorem shows a positive relationship between chnages in factors of endowments of a given country and changes in the output of the product that does use the factor intensively. In general, this model suggests that an increases  in a country’s endowment of a factor will cause an increase in output of the good that uses tha factor extensively and a decrease in output of the other good.The theorem works under the assunptions that commodity prices are held fixed and factor prices are fixed as well.

There are trade implications of this theorem, suppose that an import good is relatively capital intensive and labor increase, this may be due to the people of that region have become more educated leading to an increase in the labor, migration into the region as well can also increase labor of a country. Working under the theorem’s assumptions, there are constant prices; the increase in the amount of labor consequently increases national income of that region. Assuming both goods are normal, an increase in income will lead to an increase in demand for goods. The production of capital intensive goods has fallen and therefore the increase in demand for goods will require an increase in imports. Since the prices have not changed, the increased imports must be compensated by also increasing exports.

Relevance of the theorem using USA as evidence

There has been an increase in immigration in the United States. The Rybczynski theorem states that when a region is open to trade with other surrounding regions, changes in this regional factor supplies can be accommodated by changing regional output while keeping factor prices constant. Here, we assume that USA is a H-O region and more specifically, California since there has been settlement of low skilled immigrants in this state. During this period, California expanded production and exports of non skill intensive goods. The shift to these sectors helped California to accommodate the influx of immigrants; this increased the need for California to increase its factor prices in relation to other states of USA. Native USA workers living in states that had to a lot of immigrants shifted to other states. These regional migrations offset each other and there were relatively small changes in the endowments hence very minimal changes in the factor prices. The theorem also has a sufficient FPE condition in two states is that; the two states have the same factor requirements.

The main features of the monopolistic competition model of international trade.

The model of monopolistic competition describes a market structure in which there are many competitors but each sells a very different product. It exhibits features such as;

  • Firms make independent decisions about price and output
  • Participants are widely aware and have knowledge of what is happening but it is unlikely perfect.
  • There is freedom to enter and leave the market
  • The firms that are in the market are price makers
  • Here products are differentiated and various types of differentiation

The differentiations include;

  • Physical product differentiations where firms use size, design, color and shape and features to make their products different.
  • Marketing differentiation wherefirms try to differentiate their product by packaging differently.
  • Differentiation through distribution;this is distribution via the internet.

Opening up of trade has greatly increased the size of the markets as many countries are now trading that could not have traded previously. The increase in market size encourages more variety and welfare gains. Some of the economists have come up with ways to verify the relevance of the theorem by use of the empirical analysis by Grubel Loyd (1975). This model dismisses the issue that firms are interdependent when sets a price and does not consider any responses from the competitors which may be detrimental.

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