4

Trade and Resources:

The Heckscher-Ohlin Model

1. This problem uses the Heckscher-Ohlin model to predict the direction of trade.
Consider the production of handmade rugs and assembly line robots in Canada and
­India.
a. Which country would you expect to be relatively labor-abundant, and which is
capital-abundant? Why?
Answer Given Canada’s relatively small population (approximately 30 million
compared with more than 1 billion in India) and level of development, it is a
safe assumption that LCAN/KCAN , LIND/KIND. That is, there is more capital per
worker in Canada, making it capital-abundant compared with India. Similarly,
India would be labor-abundant.
b. Which industry would you expect to be relatively labor-intensive, and which is
capital-intensive? Why?
Answer: Given the amount of capital required to produce robots and the
amount of labor required to produce rugs, one would expect that LROBOT/
KROBOT , LRUG/KRUG, making robots capital intensive and rugs labor intensive.
c. Given your answers to (a) and (b), draw production possibilities frontiers for each
country. Assuming that consumer preferences are the same in both countries, add
indifference curves and relative price lines (without trade) to your PPF graphs.
What do the slopes of the price lines tell you about the direction of trade?

S-31
S-32  Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model

Answer: See the following figures.

Output of rugs, QR*U

Output of rugs, QRU

A*

slope = PRO/PRU
slope = PR*O /PR*U

Output of robots, QRO Output of robots, QR*O

(a) Canada (b) India


Canada’s no-trade production and consumption of robots and rugs corresponds
to a relative price of robots that is lower than that in India. This is shown by the
flatter sloped relative price line in Canada.
d. Allowing for trade between countries, redraw the graphs and include a “trade
triangle” for each country. Identify and label the vertical and horizontal sides of
the triangles as either imports or exports.
Answer: See the following figures.
Output of rugs, QR*U
Output of rugs, QRU

Exports
A*

Imports
A Imports

Exports

Output of robots, QRO Output of robots, QR*O

(a) Canada (b) India

2. Leontief’s paradox is an example of testing a trade model using actual data observa-
tions. If Leontief had observed that the amount of labor needed per $1 million of U.S.
exports was 100 person-years instead of 182, would he have reached the same conclu-
sion? Explain.
Answer: If the amount of labor required for $1 million of U.S. exports was 100
­person-years instead of 182, then the capital/labor ratio for exports would have been
$25,500 per person. Because this is larger than the corresponding ratio for imports,
this test would have provided support for the Heckscher-Ohlin theorem. That is, the
United States (which was assumed to be capital-abundant in both cases) would have
been shown to export capital-intensive goods. In actuality, however, Leontief’s test
showed exactly the opposite.
 Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model  S-33

3. Suppose that there are drastic technological improvements in shoe production at

Home such that shoe factories can operate almost completely with computer-aided
machines. Consider the following data for the Home country:
Computers: Sales revenue 5 PCQC 5 100
Payments to labor 5 WLC 5 50
Payments to capital 5 RKC 5 50
Percentage increase in the price 5 D PC/PC 5 0%  

Shoes: Sales revenue 5 PSQS 5 100

Payments to labor 5 WLS 5 5
Payments to capital 5 RKS 5 95
Percentage increase in the price 5 D PS/PS 5 50%  

a. Which industry is capital-intensive? Is this a reasonable question, given that some

industries are capital-intensive in some countries and labor-intensive in others?
Answer: WLC/RKC . WLS/RKS (and thus LC/KC . LS/KS ) implies that shoes  

are capital intensive. This is certainly possible as shown in the New Balance ap-
plication. In reality, shoes are labor-intensive in India with different production
technology. This is factor intensity reversal.
b. Given the percentage changes in output prices in the data provided, calculate the
percentage change in the rental on capital.
Answer:
For computers: D R/R 5 [(D PC/PC ) PCQC 2 (D W/W ) WLC]/RKC
         

5 [(0%)(100) 2 (D W/W )(50)]/50    

5 2 (D W/W )    

For shoes: D R/R 5 [(D PS/PS ) PSQS 2 (D W/W ) WLS )]/RKS

           

5 [(50%)(100) 2 (D W/W )(5)]/95    

5 50/95 2 (D W/W )(5/95)    

Substituting the computer equation into the shoes equation:

D R/R 5 50/95 1 (D R/R )(5/95)

     

= D R/R (90/95) = 50/95  

5 (50/90) 5 55.6%
This implies: D W/W 5 2D R/R 5 255.6%
   

c. How does the magnitude of this change compare with that of labor?
Answer: As seen in the percentage change calculation for the rental of capital in
the shoe industry, the magnitudes of the changes are equal (with opposite sign).
d. Which factor gains in real terms, and which factor loses? Are these results con-
sistent with the Stolper-Samuelson theorem?
Answer: Because the increase in capital returns (+55%) exceeds the price changes
in both industries, capital gains in real terms. Similarly, because there is a decrease
S-34  Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model

in wage (–55%) and the prices of the outputs stayed the same for computers or
increased for shoes, labor loses in real terms. This is consistent with the Stolper-
Samuelson theorem: In the long run, when all factors are mobile, an increase in
the relative price of a good will cause the real earnings of labor and capital to
move in opposite directions, with a rise in the real earnings of the factor used
intensively in the industry whose relative price went up and a decrease in the
real earnings of the other factor.
4. Using the information in the chapter, suppose Home doubles in size and Foreign
remains the same. Show that an equal proportional increase in capital and labor at
Home will change the relative price of computers, wage, rental on capital, and the
amount traded but not the pattern of trade.
Answer: An equal proportional increase in Home’s capital and labor does not
change its relative factor endowments so that the labor/capital ratio is unchanged.
With constant factor prices, your graph should show that the no-trade equilibrium
doubles. Further, the no-trade equilibrium in Foreign is unaffected because its size
remained unchanged. At the original world relative price of computers, the quantity
exported by Home exceeds the quantity Foreign wants to import, leading to a drop
in the relative price. The lower free-trade relative price of computers decreases the
rental on capital. However, labor is better off in real terms as a result of the decrease
in the relative price of computers from free trade. The pattern of trade remains the
same although the amount traded has increased. The pattern of trade is consistent
with the Heckscher-Ohlin theorem. Despite the proportional increase in its endow-
ments, Home is still capital-abundant, and it continues to export capital-intensive
goods.

QS

A*

QC

5. Using a diagram similar to Figure 4-12, show the effect of a decrease in the relative
price of computers in Foreign. What happens to the wage relative to the rental? Is
there an increase in the labor/capital ratio in each industry? Explain.
Answer: With free trade the labor-abundant Foreign country will increase production
of the labor-intensive good (shoes), leading to a rightward shift of the relative demand
curve from RD *1 to RD *2. At the new equilibrium point B *, computers are weighted
     

less, a fall in (K *C /K
  w * ), whereas the shoe industry is weighted more, a rise in (K *S /K
      w * ).
   

As a result of the rise in the relative demand for labor in the shoe industry, the relative
wage increases, which in turn lowers the labor/capital ratio in both industries.
 Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model  S-35

1. Decrease in the relative price of

computers shifts the relative demand
curve from RD*1 to RD*2

L*/K*
Wage/Rental

B*
2. The relative wage (W*/R*)2
increases from (W*/R*)1
to (W*/R*)2
A*
(W*/R*)1
L*S /K*S

RD*2

L*C /K*C RD*1

(L*C /KC* )2 (L*C /K*C )1 (L*S /K*S )2 (L*S /K*S )1 Labor/Capital

3. At the new relative wage, the labor/

capital ratio in each industry decreases

6. Suppose when Russia opens to trade, it imports automobiles, a capital-intensive good.

a. 
According to the Heckscher-Ohlin theorem, is Russia capital-abundant or
labor-abundant? Briefly explain.
Answer: Russia is labor abundant because it imports the capital-intensive good.
b. What is the impact of opening trade on the real wage in Russia?
Answer: Russia will specialize in the labor-intensive product, which will lead
to an increase the relative demand for labor in the labor-intensive industry. This
causes an increase in the relative wage. The higher relative wage cuts the num-
ber of workers hired per unit of capital in the labor-intensive industry, thereby
reducing the labor/capital ratio. By the law of diminishing returns, the decrease
in the labor/capital ratio leads to a rise in the marginal produce of labor in both
industries. Thus, the real wage will increase in Russia following trade.
c. What is the impact of opening trade on the real rental on capital?
Answer: The real rental on capital will decrease because the world relative price
of automobiles is lower than Russia’s no-trade relative price. More specifically,
with a lower labor/capital ratio in both industries, the marginal product of capi-
tal decreases so that the real rental on capital falls. Based on the Stolper-Samuelson
theorem, the abundant factor gains from trade, whereas the scarce factor loses
from trade. Russia is capital-scarce and imports capital-intensive goods, so the
real rental on capital decreases as a result of trade.
S-36  Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model

d. Which group (capital owner or labor) would support policies to limit free trade?
Briefly explain.
Answer: The capital owners will support policies to limit free trade because
they suffer a loss due to the decrease in the relative price of automobiles when
­Russia engages in trade.
7. In Figure 4-3, we show how the movement from the no-trade equilibrium point
A to a trade equilibrium at a higher relative price of computers leads to an upward
sloping export supply, from points A to D in panel (b).
a. Suppose that the relative price of computers continues to rise in panel (a), and
label the production and consumption points at several higher prices.
Answer: See the following figure.
Output Relative price
of shoes, of computers,
QS PC /PS
(PC /PS ) W 1
D2
(PC /PS ) W2 1.50
(PC /PS ) W 1.5
1.25
C2
(PC /PS ) W1 1.00 D1
C1
0.75
B1
(PC /PS ) A 0.50 A

B2

10 20 30 40 Output of 5 10 15
computers, QC

(a) Home (b) Internationa

b. In panel (b), extend the export supply curve to show how the quantity of ex-
ports at the higher relative prices of computers.
Answer: Refer to the following diagram. At the no-trade price of (PC /PS) A
  

5 0.5, Home exports 0 units of computers, which is the starting point for the
Home export supply curve in panel (b). As the world relative price of com-
puters rises, the exports of computers initially must rise on the export supply
curve, as illustrated by Home’s exports of 10 units when the world price is (PC /
PS )W1 5 1, with production at B1 and consumption at C1. But for higher prices, it
 

is possible that the export supply curve bends backward, as illustrated by the world
price of (PC /PS )W2 5 1.5, where the export supply is less than 10 units, with pro-
 

duction at B2 and consumption at C2. At these points, consumption of computers

is 30 units and production is below 40 units, say 39 units, so exports are 9 units.
Ultimately, at the corner solution, the world relative price of computers will be
completely vertical, meaning the PC /PS = infinity.
 Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model  S-37

Relative price
of computers,
PC /PS
1 Home
D2 exports
(PC /PS ) W2 1.50
W 1.5
S)
1.25

(PC /PS ) W1 1.00 D1

0.75

(PC /PS ) A 0.50 A

Foreign
imports
B2

40 Output of 5 10 15 Quantity of
computers, QC computers

(b) International Market

c. What happens to the export supply curve when the price of computers is high
enough? Can you explain why this happens? Hint: An increase in the relative
price of a country’s export good means that the country is richer because its
terms of trade have improved. Explain how that can lead to fewer exports as
their price rises.
Answer: As the world-relative price for computers rises, this is a terms-of-trade
gain for the Home country, which exports computers. From the point of view of
Home consumers, it is like a rise in income, so they consume more of both com-
puters and shoes (the income effect). On the other hand, the rise in the relative
price of computers leads them to substitute away from this good (the substitution
effect). When the income effect dominates the substitution effect, as will occur for
sufficiently high increases in the terms of trade, then exports of computers will fall
due to increased Home demand.
8. On March 2, 2013, Tajikistan successfully negotiated terms to become a member
of the World Trade Organization. Consequently, countries such as those in western
Europe are shifting toward free trade with Tajikistan. What does the Stolper-Samu-
elson theorem predict about the impact of the shift on the real wage of low-skilled
labor in western Europe? In Tajikistan?
Answer: According to the Stolper-Samuelson theorem, the real wage of unskilled
labor in Western Europe will experience a decrease in real earnings because Western
Europe is skilled-abundant relative to Tajikistan and will specialize in the skilled-
intensive good. By trading with Tajikistan, the relative price of the skilled-intensive
good will rise. In Western Europe, this leads to an increase in the real earnings of
skilled labor and a decrease in the real wage of unskilled labor. The situation would
be opposite in the Tajikistan, where the real wage of unskilled labor would increase.
9. The following are data on U.S. exports and imports in 2012 at the two-digit Har-
monized Tariff Schedule (HTS) level. Which products do you think support the
Heckscher-Ohlin theorem? Which products are inconsistent?
S-38  Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model

Export Import
HTS Level Product ($ billions) ($ billions)

   22 Beverages 6.4 19.2

   30 Pharmaceutical products 38.0 64.1
   52 Cotton 8.2 1.1
   61 Apparel 1.4 41.1
   64 Footwear 0.8 23.7
   72 Iron and steel 22.0 29.0
   74 Copper 9.3 10.2
   85 Electric machinery 105.0 289.0
   87 Vehicles 122.3 240.0
   88 Aircraft 95.8 24.2
   94 Furniture 8.7 44.3
   95 Toys 4.4 27.0
Source: International Trade Administration, U.S. Department of Commerce.


Answer: Because the United States is relatively abundant in skilled labor and scarce
in unskilled labor, as predicted by the Heckscher-Ohlin model the U.S. imports
unskilled-labor–intensive goods such as apparel, footwear, furniture, and toys. As-
suming pharmaceutical products use skilled labor, U.S. imports of these goods are
contrary to the prediction of the model. Both skilled labor and capital are used inten-
sively in the production of aircraft, and given that the United States has abundance in
both factors, the export of this good supports the Heckscher-Ohlin model. However,
the model is unsupported by the import of electric machinery and vehicles as both
goods also use intensively skilled labor and capital. The export of cotton is also likely
to contradict the Heckscher-Ohlin model because the United States is relatively land
scarce.
10. Following are data for soybean yield, production, and trade for 2010–2011:

Production Export Import

Yield (metric (100,000 (100,000 (100,000
ton/hectare) metric ton) metric ton) metric ton)

Australia 1.71 0.29 0.025 0.007

Brazil 3.12 748.2 258 1.18
Canada 2.75 42.5 27.8 2.42
China 1.89 144 1.64 570
France 2.95 1.23 0.24 5.42
Japan 1.60 2.19 0.0006 34.6
Mexico 1.32 2.05 0.001 37.7
Russian Federation 1.48 17.6 0.008 10.7
United States 2.79 831 423 4.45
Source: Food and Agriculture Organization.

Suppose that the countries listed in the table are engaged in free trade and that soy-
bean production is land-intensive. Answer the following:
a. In which countries does land benefit from free trade in soybeans? Explain.
Answer: Landowners in the United States, Brazil, and Canada benefit from free
trade since the production of soybeans intensively uses land as a factor of produc-
tion, since these countries export more soybeans than they import.
 Solutions  n  Chapter 4  Trade and Resources: The Heckscher-Ohlin Model  S-39

b. In which countries does land lose from free trade in soybeans? Explain.
Answer: As net importers of soybeans, landowners in Australia, China, Mexico,
Japan, Russia, and France lose from free trade because the world-relative price
of soybeans is lower than each country’s no-trade equilibrium price.
c. In which countries does the move to free trade in soybeans have little or no ef-
fect on the land rental? Explain.
Answer: None.
According to the Heckscher-Ohlin model, two countries can equalize wage differ-
11. 
ences by either engaging in international trade in goods or allowing high-skilled and
low-skilled labor to freely move between the two countries. Discuss whether this is
true or false, and explain why.
Answer: Allowing skilled workers to migrate to skilled-labor-scarce countries
and unskilled workers to migrate to unskilled-labor-scarce countries reduces the
ratio of skilled/unskilled workers in the skilled-labor-abundant country and raises
it in the u
­ nskilled-labor-abundant country. This increases the wage ratio between
skilled and unskilled labor in the skilled-labor-abundant country and lowers it in
the ­unskilled-labor-abundant country.
When the two countries trade in goods that embody these factors, the skilled-labor-
abundant country will export the skilled-labor-intensive good. By doing so, it ef-
fectively sends a lot of skilled workers and a few unskilled workers to the unskilled-­
labor-abundant country. Likewise, when it imports the unskilled-labor-intensive
good, it effectively imports a few skilled workers and a lot of unskilled workers. The
net effect is skilled workers in the unskilled-labor-abundant country see a fall in their
wage relative to unskilled labor and unskilled workers experience a rise in their rela-
tive wage, similar to that of migration.
When all the strict assumptions of the Heckscher-Ohlin model are satisfied, we can
get this factor price equalization theory: trade leads to equalization of returns to fac-
tors across countries. As product prices in two countries converge to the same world
price level, the difference in the factor prices narrows, and ultimately disappears. But
this theory should not be viewed as Holy Grail as it requires “extraordinary demand-
ing” assumptions that are not quite satisfied in the reality.
According to the standard Heckscher-Ohlin model with two factors (capital and
12. 
labor) and two goods, movement of Turkish migrants to Germany would decrease
the amount of capital-intensive products produced in Germany. Discuss whether this
is true or false, and explain why.
Answer: An increase in a factor of production raises the production of the good
that uses that factor intensively and reduces the production of the other good. So as
labor flows from Turkey to Germany, labor endowment increases in Germany. The
production of labor-intensive goods relative to capital-intensive goods will increase
in Germany.