1. NEOCLASSICAL TRADE THEORY
CHAPTER 3
NEOCLASSICAL TRADE THEORY

2. affect the distribution of income
Review
Beneficial to everybody
One input
Two or more inputs
H-O Model
Specific Factor Model
affect the distribution of income

3. Neoclassical Compare with Classical
Factor
Two or more than two
One factor
Study technique
General equilibrium
Partial equilibrium
Emphases
Income distribution
Gain from trade

4. The Heckscher-Ohlin Model （Factor Endowment Theory)
Founder
The basic H-O model
Testing the H-O model
Summary

5. H-O Model’s Founder: Ohlin
Bertil Ohlin
1977 Nobel Prize Winner
Wrote between 1921 and 1949.

6. H-O Model’s Founder: Heckscher
ELI FILIP HECKSCHER
Famous Swedish Economist
Wrote on Mercantilism, Swedish History, and International Economics

7. The basic H-O Model Relations with Ricardian Model Basic Assumptions
Basis for trade
Pattern of production and trade
Numerical example
Effects of Trade
Rybczyski Theorem

8. Relations with Ricardian Model
What are the ultimate determinants of comparative advantage?
Ricardo did not bother to answer this question
He just assumed that the differences in comparative advantage depended on comparative difference in labor productivity (that is, differences in technology), but he did not explain the basis for these differences. Implicit reason in his example was climate...

9. Relations with Ricardian Model
It remained to Heckscher and Ohlin to offer an explanation for this. And this theory has become, since 1930s, the orthodox explanation of the ultimate cause of international trade
Their basic idea is:
1. Commodities differ in their factor requirements
2. Countries differ in their factor endowments

10. Relations with Ricardian Model
A country has comparative advantage in those commodities that use its abundant factors intensively.
This is why labor-abundant countries, such as India, China and Korea export footwear, rugs, textiles, and other labor intensive commodities; and land-abundant countries, such as Argentina, Australia, and Canada, export meat, wheat, wool, and other land-intensive commodities

11. Basic Assumptions
1. Number of countries, factors, and commodities are all two 2 x 2 x 2 model
Two inputs (factors): Labor (L) & Capital (K)
Two outputs: Cloth (Qc) & Steel (QS)
Two Countries, e.g. US & China
Different proportion of factor endowment:
US is a capital-abundant country and China is a labor-abundant country (K/L)US > (K/L)China

12. Basic Assumptions
2. Technology is the same in both countries same production functions
Qc = Qc (Kc, Lc), QS = QS (KS, LS)
（cloth is labor-intensive good both in US & China )
3. Strong factor intensity
Cloth is labor-intensive good , Steel is capital-intensive good  At any given factor price ratio w/r,
KS /LS > Kc /Lc

13. Basic Assumptions 4. Constant returns to scale
5. Incomplete specializationincreasing opportunity costs
6. Perfect competition
7. Factors are perfectly mobile within each country but not so between countries
8. Tastes are largely similar between countries
9. Free trade, transportation costs are zero

14. Factor Abundance (1) “physical” Definitions
Cloth
Steel
PPFChina
PPFUS A B
Physical definition is based on the total amounts of factors:
US is relatively capital abundant compared to China

15. Factor Abundance (2) “price” Definitions
Price definition uses wage/rental ratios:
US is relatively capital abundant compared to China. (Why?) K
Iso-cost line for US
Isoquant line A B
Iso-cost line for China C D L

16. Factor Intensive K
KS /LS
Isoquant line
Iso-cost line
Kc /Lc L

17. Basis for Trade factor endowments, technology and tastes
The structure of trade, in general, can be traced back to differences in
factor endowments, technology and tastes
Since Heckscher-Ohlin theory assumes that technology and tastes are similar between countries, it attributes the comparative advantage to differences in factor endowments

18. Basis for Trade Different relative factor endowments
different relative factor prices
different relative production cost
different relative prices of products
Comparative advantage in producing and exporting the product that uses its abundant recourse intensively (lower relative cost)

19. Pattern of production and trade
The capital-abundant country exports the capital-intensive commodity, and the labor-abundant country exports the labor-intensive commodity.
In this case, US should export steel and China should export cloth.

20. Numerical example
One country
Required inputs per unit of output

21. Derivation of PPF (one country)
Cloth
600 • M
Capital Constraint
If the economy had an unlimited supply of capital (labor), it would be able to produce along the labor constraint JG (capital constraint MH). When the supplies of both factors are limited, both constraints become binding and the production frontier coincides with the heavy kinked line JEH. Because steel is capital intensive relative to cloth, the capital constraint is steeper than the labor frontier. J
225 • E •
Labor constraint
150 G H • •
150
200
450
Steel

22. Derivation of PPF (two countries)

23. Graphical Presentation

24. Effects of Trade To relative price of goods To Factor Prices
Trade increase the relative price of goods for export, while decrease that for import.
To Factor Prices
To production
More resources are used in the productions for export.
To consumption
Comparing with close economy state, the consumptions possibility rise, but the consumptions for both goods need not rise. It depend on the relative price change and community preferences

25. Effects of Trade on Factor Prices
Short-Run (no factors are mobile among sectors)
Long-Run (all factors are able to move among sectors )
The Factor Price Equalization Theorem & Stopler - Samuelson theorem

26. Short-Run Effect Return to factors w = P x MPL r = P x MPK
（No changes in marginal productivity of factor ，so w&r are determined by changes in Product Price）
Price of export product , both factors in the export sector gain
Price of import-competing product , both factors in the import-competing sector loss

27. Long-run Effect 1. The Stolper-Samuelson (S-S) Theorem
Free trade raises the return to the factor used intensively in the rising-price sector (export sector) and lowers the return to factor used intensively in the falling-price (import competing sector)
2. Effect on distribution of income
Owners of a country’s abundant factors gain from trade,but owners of scarce factors lose.