Transcript Document

A Model of a Two-Factor Economy
 Resources and Output
• How is the allocation of resources determined?
– Given the relative price of cloth and the supplies of land
and labor, it is possible to determine how much of each
resource the economy devotes to the production of each
good.
18th Sept
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Slide 4-1
A Model of a Two-Factor Economy
Figure 4-5: The Allocation of Resources
LF
1
TC
F
OC
Labor used in cloth production LC
18th Sept
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OF
C
TF
Land used in food production
Land used in cloth production
Increasing
Labor used in food production
Increasing
Slide 4-2
A Model of a Two-Factor Economy
 How
do the outputs of the two goods change when
the economy’s resources change?
• Rybczynski Theorem (effect):
– If a factor of production (T or L) increases, then the
supply of the good that uses this factor intensively
increases and the supply of the other good decreases for
any given commodity prices.
– The reverse is also true.
18th Sept
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Slide 4-3
A Model of a Two-Factor Economy
Increasing
Labor used in food production
L2F
O2 F
L1F
O 1F
1
T1C
T2 C
2
F2
OC
C
F1
Labor used in cloth production L2C
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L1C
T 1F
T 2F
Land used in food production
Land used in cloth production
Figure 4-6: An Increase in the Supply of Land
Increasing
Slide 4-4
A Model of a Two-Factor Economy
Figure 4-7: Resources and Production Possibilities
Output of
food, QF
Slope = -PC/PF
2
Q2 F
Slope = -PC/PF
Q1
1
F
TT1
Q2 C Q 1 C
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Outward shift in PPF
Biased towards food
-good which is more
Capital intensive
TT2
Output of
cloth, QC
Slide 4-5
A Model of a Two-Factor Economy
 An increase in the supply of land (labor) leads to a


biased expansion of production possibilities toward
food (cloth) production.
The biased effect of increases (decreases) in resources
on production possibilities is the key to understanding
how differences in resources give rise to international
trade.
An economy will tend to be relatively effective at
producing goods that are intensive in the factors with
which the country is relatively well-endowed.
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Slide 4-6
Effects of International Trade
Between Two-Factor Economies
 Assumptions of the Heckscher-Ohlin model:
• There are two countries (Home and Foreign) that have:
– Same tastes
– Same technology
– Different resources
– Home has a higher ratio of labor to land than Foreign
does
• Each country has the same production structure of a
two-factor economy.
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Slide 4-7
Effects of International Trade
Between Two-Factor Economies
 Relative Prices and the Pattern of Trade
• Factor Abundance
– Home country is labor-abundant compared to Foreign
country (and Foreign is land-abundant compared to
Home) if and only if the ratio of the total amount of
labor to the total amount of land available in Home is
greater than that in Foreign:
L/T > L*/ T*
– Example: if America has 80 million workers and 200 million
acres, while Britain has 20 million workers and 20 million
acres, then Britain is labor-abundant and America is landabundant.
18th Sept
– In this case, the scarce factor in Home is land and in
Foreign is labor.
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Slide 4-8
Effects of International Trade
Between Two-Factor Economies
• When Home and Foreign trade with each other, their
relative prices converge. The relative price of cloth
rises in Home and declines in Foreign.
– In Home, the rise in the relative price of cloth leads to a
rise in the production of cloth and a decline in relative
consumption, so Home becomes an exporter of cloth
and an importer of food.
– Conversely, the decline in the relative price of cloth in
Foreign leads it to become an importer of cloth and an
exporter of food.
18th Sept
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Slide 4-9
Effects of International Trade
Between Two-Factor Economies
Figure 4-8: Trade Leads to a Convergence of Relative Prices
Relative price
of cloth, PC/PF
RS*
RS
3
2
1
RD
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Relative quality
of cloth, QC + Q*C
Q F + Q *F
Slide 4-10
Effects of International Trade
Between Two-Factor Economies
 Heckscher-Ohlin Theorem:
• A country will export that commodity which uses
intensively its abundant factor and import that
commodity which uses intensively its scarce factor.
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Slide 4-11