1. Chapter 2
Inter-Industry Trade
Inter-industry trade
Inter-firm trade

2. What are the effects of trade in the long run, when countries differ in endowments?
Heckscher-Ohlin model:
The main differences with the Ricardian model:
Source of comparative advantage is the difference in resources endowments;
Two resources (factors of production) that are not specific to any industry: they are mobile across sectors
Technologies are the same across countries

3. Four theorems:
Heckscher-Ohlin theory: how resource endowments affect the pattern of trade
Rybczynski theory: how endowments affects production of a country
Stolper-Samuelson theory: how changes in relative price due to trade influence the distribution of gains within countries
Factor-Price Equalization theory: how trade affect the price of factors across countries

4. Heckscher-Ohlin theory
Two countries Home and Foreign
Two goods x and y
Two endowments, labor (L) and capital (K)
Perfect competition
K and L are used to produce x and y
Factors are mobile across sectors and immobile across countries
Fixed coefficients technologies (identical in the two countries)
Unit input requirements
kx and lx are the amount of K and L required to produce one unit of x
ky and ly are the amount of K and L required to produce one unit of y
Two constraints:
kx Qx + ky Qy  K
lx Qx + ly Qy  L
Qx = K/kx - ky/kx Qy
Qx = L/lx - ly/lx Qy

5. Factor intensity: a key concept in the Heckscher-Ohlin model
Technologies differ across industries, but are the same across countries
Good x is capital intensive if
kx/lx > ky/ly, or kx/ky > lx/ly
Good y is labor intensive because
ly/ky > lx/kx, or ly/lx > ky/kx
Factor intensity is due to technologies and it is the same across countries

6. The production possibility frontier Qx = K/kx - ky/kx Qy
The production possibility frontier Qx = K/kx - ky/kx Qy Qx = L/lx - ly/lx Qy

7. How are endowments and outputs related? The Rybczynski theory
An increase in K (L) shifts the capital (labor)constraint to the right;
As a result, the production possibilities of good x (y) which uses more intensively capital (labor) increases.

8. An increase in K increases the production possibilities Qx = K/kx - ky/kx Qy

9. This means that :
over time, a country that increases the endowment of a factor, it increases also its production possibilities in the good that uses more intensively that factor;
countries that differ in endowments will produce goods that use their abundant endowment more intensively

10. How are goods prices and factor prices related
How are goods prices and factor prices related? Stolper Samuelson theory
Perfect competitive equilibrium in the factor market:
Px = kx r + lx w
Py = ky r + ly w
By rearranging:
r = Px/kx - lx/kx w (1)
r = Py/ky - ly/ky w (2)
Because we assume that y is the industry labor intensive and x is the industry capital intensive then the slope of the first (1) equation is lower than the slope of the second (2)

11. How are goods prices and factor prices related. r = Px/kx - lx/kx w
How are goods prices and factor prices related? r = Px/kx - lx/kx w (1) r = Py/ky - ly/ky w (2) )

12. Assume that Px price increases from Px0 to Px1 The rental rate increases to r1 and the wage decreases to w1
r = Px/kx - lx/kx w (1) r = Py/ky - ly/ky w (2)
Px1-Px0
r1- r0

13. Stolper Samuelson theory
An increase in the price of a good will result in an increase of the nominal rate of return of the factor that is intensively used in the production of that good;
What is the effect on the real rate of returns?
|(r1 - r0)| > |(Px1 - Px0)| |(w1 - w0)| > |(Px1 - Px0)|
Also the real rate will change according to the Stolper Samuelson theory
The SS theory applies both to changes in price over time in a certain country and to changes in price across countries at the same time

14. Stolper Samuelson theory
Magnification Effect
The magnitude of the changes in nominal factor prices exceeds the magnitude of the changes of prices
Both real and nominal rate of return move in the same direction as a result of price changes

15. Two countries in the HO theory
Assume that Foreign has the same technology as at Home
(kx/lx) = (kx*/lx*) and (ky/ly) = (ky*/ly*)
With
(kx/lx) > (ky/ly) and (kx*/lx*) > (ky*/ly*)
That is , x is the capital intensive industry and y is the labor intensive industry
But countries differ in resources endowments
K/L > K*/L*
That is, Home is capital abundant and Foreign is labor abundant

16. What are the production possibilities at Home?

17. And in the Foreign country
And in the Foreign country? The slope of constraints are the same (same technology) but a different intercept reflects different resource endowment
Home

18. Two countries in the HO theory: autarchy
PPF at Home is biased toward x that uses capital more intensively;
PPF in the Foreign country is biased toward y that uses labor more intensivel

19. Two countries in the HO theory: autarchy
Relative price of good x will be lower at Home:
Px/Py = lx/ ly < P*x/P*y = kx/ky
This reflects the relative abundance of capital that is intensively used in the production of x ;
Rents (wages) at Home are lower (higher) than in Foreign (Stolper Samuleson);

20. What are the world prices with free trade and the patterns of trade?
As in the Ricardian model countries trade if prices are more favorable than in autarchy
The world relative supply is Qyw /Qxw
with
Qxw = Qx + Qx* and Qyw = Qy + Qy*
Remember that the autarchy relative price is equal in H to the slope of the labor constraint Px/Py = lx/ ly and in F to the slope of the capital constraint P*x/P*y = kx/ky

21. Pattern of trade in the HO model:
Countries will produce and export goods that are intensive in the country’s abundant factor endowment;
Countries will import goods that are intensive in the country’s scarce factor endowment

22. Py*/Px* < Pyw/Pxw < Py/Px or ky/kx < Pyw/Pxw < ly/lx
Hence under free trade the price falls in a range in between the autarchy prices
Py*/Px* < Pyw/Pxw < Py/Px or
ky/kx < Pyw/Pxw < ly/lx
If price is lower than ky/kx none of the countries will produce good y ; If price is higher than ly/lx both countries produce only y

23. The world supply is a kinked curve: trade occurs only if world price is in between the two autarchy prices

24. What are the gains from trade? And the distribution of gains?
Like the Ricardian model, also in the HO model trade both countries gain because of an increase in their consumption possibilities ;
Unlike the Ricardian model, the HO model provides us with predictions about the domestic distribution of gains from trade
What happens to r and w when the countries open to trade?

25. With free trade Home country will experience an increase in the relative price of x; This shifts upward equation 1: r increases and w decreases

26. With free trade Foreign country will experience an increase in the relative price of y; this shifts upward equation 2: r decreases and w increases

27. At Home, the capital abundant country, free trade implies an increase in the nominal and real rental rate paid to capital owners and a decreases in the real and nominal wage; capital owners gain and workers loose;
In the foreign country, the labor abundant country, free trade implies an increase in the nominal and real wage rate paid to workers and a decrease in the real and nominal rental rate; capital owners loose and workers gain.

28. Factor-Price Equalization theory
Factor-Price are equalized across countries as a result of trade;
In autarchy the capital (labor) abundant country has a relatively low rental (wage) rate
As home (Foreign) opens to trade, rents (wages) rise and wages (rents) fall;
Wages and rental rates continue to change up to when
Pxw = ww lx + rw kx Pyw = ww ly + rw ky

29. 2.2.7 What are the effects of liberalizing trade policy?