7/23/2019 poritza

1/33

Trade TheoremsEmpirical Tests

(Intuitive Proofs)

7/23/2019 poritza

2/33

2

Core TheoremsThe Heckscher-Ohlin Theorem

The effect of endowments on pattern of trade.

The Law of One-Price Theorem

The effect of trade on product pricesThe Factor-Price Equalization Theorem

The effect of trade on factor prices.

The Stolper-Samuelson Theorem

The effect of goods prices on factor prices.

7/23/2019 poritza

3/33

3

Assumptions2x2x2 - 2 Countries, 2 Goods, 2 Factors

Perfect competition, homogeneous andmobile (within the economy) factors, fullemployment.

Diminishing returns to a single factor.

Common technology between countries.

Different factor endowments.Different factor intensities in industries.

Identical preferences. (Why?)

7/23/2019 poritza

4/33

4

Definitions

Factor intensity or factor proportions.

The proportion of factors used in theproduction of any one final good, e.g:

If:

X is a capital-intensive good.

Y is a labor-intensive good. (Why?)

X

X

Y

Y

LK

LK )()( ** LKLK

> )()( ** rwrw

7/23/2019 poritza

6/33

6

Setup

Suppose that the Foreign economy and

the home economy have identicalendowments of capital and labor, so that:

Given that technology is the same, whatmust the transformation loci look like?

Given the same preferences, what doesthis imply about autarky prices and thepattern of comparative advantage?

)()( **

LKLK =

7/23/2019 poritza

7/33

7

Y*

X*

MRT*=MRS*

Y

X

MRT=MRS

7/23/2019 poritza

8/33

8

Let us assume that production of X iscapital-intensive, while production of Y

is labor intensive.Now suppose that the stock of capital was

to grow in Home while the stock of labor

was to grow in Foreign.

How would the transformation loci

change?

7/23/2019 poritza

9/33

9

Y*

X*

MRT*=MRS*Y

X

MRT=MRS

7/23/2019 poritza

10/33

7/23/2019 poritza

11/33

11

By our definition, Foreign has a

comparative advantage in Y, while Homehas a comparative advantage in X.

Those CA are sourced from differentrelative factor endowments, since that isthe only difference between Home and

Foreign. Thus we can formulate the HO theorem

which links relative factor endowments

and the pattern of trade:

Comparative Advantage

7/23/2019 poritza

12/33

12

Heckscher-Ohlin Theorem

Definition: Each country exports the

commodity which requires for itsproduction the relatively intensive useof the factor found in relativeabundance in that country

7/23/2019 poritza

13/33

13

Law of One-Price Theorem

Differing autarky prices trigger trade to

take place between two countries

Common supply and demand conditions

result in common equilibrium price apartfrom transport costs and tariffs

In free trade only one commodity price will

prevail and autarky prices disappear

7/23/2019 poritza

14/33

14

States that under certain circumstances

free trade in goods will equalize bothabsolute and relative factor pricesacross countries.

Commodity trade can be seen as a perfectsubstitute for international factor mobility

(because equalization of factor pricescould be achieved directly throughmobility).

Factor-Price EqualizationTheorem

7/23/2019 poritza

15/33

15

Stolper-Samuelson Theorem Theorem: Under certain circumstances,

an increase in the relative price of a goodwill unambiguously increase the realreturn to the factor used relativelyintensively in the production of that good,while real return to the other factor will be

reduced in terms of both goods.

7/23/2019 poritza

16/33

7/23/2019 poritza

17/33

17

An increase in relative price of X shiftsits unit-value isoquant inward (why?).

This alters the relative factor prices.That is, the relative rental (reward tointensively used capital in X) rises.

Note the effect on factor intensity ratiosin each industry.

7/23/2019 poritza

18/33

18

Which Theory Is Correct?

Several theories explain international trade patterns(Classical, Ricardian (neoclassical), and Heckscher-Ohlinmodels).

Must we adopt a single theory of trade?

I.e., Is one of the models sufficient to explain whyColombia exports coffee, Taiwan color TVs, or

Brazil steel?

Might the different theories best explain variousaspects of trade better?

Do the existing theories explain todays trade patternswell? Or do we need to modify any of these theories tobetter explain todays patterns?

7/23/2019 poritza

19/33

19

How Do We Know If a Theory About

Trade Is Correct?

Economists turn to empirical testing in

order to strengthen their arguments aboutthe different theories and indicate theinfluences on various types of trade.

E.g., Both Adam Smith and David Ricardoused rudimentary empirical testing to support

their claims.

7/23/2019 poritza

20/33

20

How Do We Know If a Theory AboutTrade Is Correct?1.1.Testing Classical Theory of Trade

Differences in productivity as basis of trade

Differences in Opportunity cost as basis of trade

1.2. Testing the Hecksher-Ohlin model

Differences in Resource endowment as basis of Comparativeadvantage and trade?

Do the exporting industries use more of the abundant factor?

Do the factor contents of exports and imports match the

relative abundance of factors

7/23/2019 poritza

21/33

21

How Do We Know If a Theory About

Trade Is Correct?

Empirical testing of international trade

theories Difficulties with empirical testing---

Empirical evidence can appear to support a

theory, but it cannot prove that the theory is true(or vice versa).

Most useful outcome of empirical test isrefinement of both theory and test.

7/23/2019 poritza

22/33

7/23/2019 poritza

23/33

7/23/2019 poritza

24/33

7/23/2019 poritza

25/33

25

Explanations - Leontief Paradox

Some imports depend on a countrysresources, not just capital and labor

Capital intensive resource extraction leads to

increase of capital intensive imports

US labor intensive industries are heavilyprotected

Decrease of labor intensive imports

7/23/2019 poritza

26/33

26

Assumed labor is homogeneous

Labor differs by levels of human capital

US exports not labor intensive but humancapital intensive

Technology differs from other factors

US exports are more technology intensive

7/23/2019 poritza

27/33

7/23/2019 poritza

28/33

7/23/2019 poritza

29/33

29

Fine-Tuning the Heckscher-

Ohlin Model

Including the role of tastes/preferences Using different classification of inputs

Taking into account technology and

productivity differentials

Adjusting for Unbalanced Trade

7/23/2019 poritza

30/33

30

Fine-Tuning the Heckscher-

Ohlin Model Role of Tastes

Heckscher-Ohlin model assumed tastes were identical across

countries. Differences in tastes among countries can introduce a taste

bias that can dominate the production bias (Implied by HO).

Should this occur, a country will have a comparativeadvantage in production of the good that uses its scarcefactor intensively.

Evidence does exist for a home bias in consumption

(consumers in a given country often tend to consumemore domestically produced goods than we wouldexpect).

7/23/2019 poritza

31/33

31

Fine-Tuning the Heckscher-

Ohlin Model Classification of Inputs

The Original theory used only two inputs: capital andlabor. However, inputs are generally classified inseveral waysmost commonly:

Arable (cultivable), non-Arable (uncultivable)

Land Man Made (synthetic) and Natural (Raw

materials) resources

Human capital (high skilled, educated and

trained) and Nonhuman capital (Low skilled,Manual labor)

7/23/2019 poritza

32/33

7/23/2019 poritza

33/33