Trade and Resources:

4
The Heckscher-Ohlin Model

1. This exercise uses the Heckscher-Ohlin model to predict the direction of trade.
Consider the production of hand-made rugs and assembly line robots in Canada and
India.
a. Which country would you expect to be relatively labor-abundant, and which
capital-abundant? Why?
Answer Given Canada’s relatively small population (⬃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 la-
bor-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?

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

Answer: See the following figures.

Output of rugs, QRU*

Output of rugs, QRU

A*

Output of robots, QRO Output of robots, QRO*

(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 tri-
angle” 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, QRU*
Output of rugs, QRU

Exports
A*

Imports
A Imports

Exports

Output of robots, QRO Output of robots, QRO*

2. Leontief ’s paradox is an example of testing a trade model using actual data observations.
If Leontief had observed that the amount of labor needed per $1 million of U. S. ex-
ports was 100 instead of 182, would he have reached the same conclusion? 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 ■ 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 ⫽ PCQC ⫽ 100
Payments to labor ⫽ WLC ⫽ 50
Payments to capital ⫽ RKC ⫽ 50
Percentage increase in the price ⫽ ⌬PC / PC ⫽ 0%
Shoes: Sales revenue ⫽ PSQS ⫽ 100
Payments to labor ⫽ WLS ⫽ 5
Payments to capital ⫽ RKS ⫽ 95
Percentage increase in the price ⫽ ⌬PS / PS ⫽ 50%
a. Which industry is capital-intensive? Is this a realistic scenario (i. e. , are some in-
dustries 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 Bal-
ance application.
b. Given the percentage changes in output prices above, calculate the percentage
change in the rental on capital.
Answer:
For computers: ⌬R / R ⫽ [(⌬PC / PC ) PCQC ⫺ (⌬W / W) WLC] / RKC
⫽ [(0%)(100) ⫺ (⌬W / W)(50)] / 50
⫽ ⫺ (⌬W / W)

For shoes: ⌬R / R ⫽ [(⌬PS / PS ) PSQS ⫺ (⌬W / W) WLS )] / RKS

⫽ [(50%)(100) ⫺ (⌬W / W)(5)] / 95
⫽ 50 / 95 ⫺ (⌬W / W)(5/95)
Substituting the computer equation into the shoes equation:

⌬R / R ⫽ 50 / 95 ⫹ (⌬R / R)(5 / 95)

⫽ (50 / 90) ⫽ 55. 6%
This implies: ⌬W / W ⫽ ⫺⌬R / R ⫽ ⫺55. 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 exceeds the price changes in
both industries, capital gains in real terms. Similarly, because there is a decrease
in wage and the prices of the outputs stayed the same or increased, 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
S-34 Solutions ■ Chapter 4 Trade and Resources: The Heckscher-Ohlin Model

a rise in the real earnings of the factor used intensively in the industry whose rel-
ative 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 re-
mains 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 con-
stant 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 rel-
ative 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 increase in the rel-
ative price of computers from free trade. The pattern of trade remains the same al-
though the amount traded has increased.
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
苶 * ), whereas the shoe industry is weighted more, a rise in (K *S /
less, a fall in (K *C / K
苶 ). As a result of the rise in the relative demand for labor in the shoe industry, the rel-
K *

ative wage increases, which in turn lowers the labor/capital ratio in both industries.

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 / K*C )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
 Solutions ■ Chapter 4 Trade and Resources: The Heckscher-Ohlin Model S-35

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 cap-
ital decreases so that the real rental on capital falls.
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 slop-
ing 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 figures.
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 ⫽
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 computers 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 ⫽ 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 ⫽ 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.
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
S-36 Solutions ■ Chapter 4 Trade and Resources: The Heckscher-Ohlin Model

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.
Output Relative price
of shoes, of computers,
QS PC / PS

( PC / PS ) W ⫽1 Home
D2 exports
( 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
Foreign
imports
B2

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

(a) Home (b) International Market

8. In 2008, the Ukraine 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 the Ukraine. What does the Stolper-Samuelson the-
orem predict about the impact of the shift on the real wage of unskilled labor in West-
ern Europe? In the Ukraine?
Answer: According to the Stolper-Samuelson theorem, the real wage of unskilled la-
bor in Western Europe will experience a decrease in real earnings because Western
Europe is skilled-abundant relative to the Ukraine and will specialize in the skilled-
intensive good. By trading with the Ukraine, the relative price of the skilled-inten-
sive good will rise. 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
Ukraine, where the real wage of unskilled labor would increase.
9. The following are data on U. S. exports and imports in 2007 at the two-digit har-
monized schedule (HS) level. Which products do you think support the Heckscher-
Ohlin theory? Which products are inconsistent?
 Solutions ■ Chapter 4 Trade and Resources: The Heckscher-Ohlin Model S-37

Export Import
HS Code Product ($ billions) ($ billions)

22 Beverages 3.6 14.7

30 Pharmaceutical products 40.7 55.6
52 Cotton 4.9 0.8
61 Apparel 1.9 33.3
64 Footwear 1.0 17.6
72 Iron and steel 15.4 12.4
74 Copper 5.0 6.4
85 Electric machinery 124.9 212.1
87 Vehicles 73.6 131.9
88 Aircraft 83.0 18.4
94 Furniture 7.0 30.1
95 Toys 7.0 27.6
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 un-
skilled-labor–intensive goods such as apparel, footwear, furniture, and toys. Assuming
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 intensively in
the production of aircraft, and given that the United States has abundance in both fac-
tors, 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. Data for soybean yield, production, and trade are provided below for 2007.

Production Exports Imports

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

Australia 2.44 3.2 0.3 1.0

Brazil 2.81 5785.7 2373.4 9.8
Canada 2.30 269.6 186.8 21.3
China 1.45 1272.5 45.7 3315.0
France 2.60 8.5 1.7 49.4
Ireland 3.13 40.8 2.0 8.4
Japan 1.64 22.7 0.1 416.1
Mexico 1.41 8.8 0.0 361.1
Russian Federation 0.92 65.0 1.7 12.5
United States 2.81 7286.0 2984.0 27.6
Source: Food and Agriculture Organization.

Suppose that the countries listed above are engaged in free trade and that soybean
production is land intensive. Then answer:
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 pro-
duction.
S-38 Solutions ■ Chapter 4 Trade and Resources: The Heckscher-Ohlin Model

b. In which countries does land lose from free trade in soybeans? Explain.
Answer: Landowners in China, Mexico, Japan, Ireland, 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: The move to free trade in soybeans is likely to have little or no effect
on the land rental in Australia and Russia because their import and export of the
product is about equal.
11. According to the Heckscher-Ohlin model, two countries can equalize wage differ-
ences by either engaging in international trade in goods or allowing skilled and un-
skilled labor to freely move between the two countries. Comment.
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 unskilled-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 effec-
tively 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.
12. According to the standard Heckscher-Ohlin model with two factors (capital and la-
bor) 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.