A Model of a two-Factor Economy Figure 4-7: Resources and production possibilities Output of food, QF 2 Slope=-PcPF F Slope =-PC/PF cC Output of cloth Q Copyright C 2003 Pearson Education, Inc Slide 4-16
Copyright © 2003 Pearson Education, Inc. Slide 4-16 TT1 TT2 Output of food, QF Output of cloth, QC Slope = -PC/PF Slope = -PC/PF 2 Q2 F Q2 C 1 Q1 F Q1 C A Model of a Two-Factor Economy Figure 4-7: Resources and Production Possibilities
A Model of a two-Factor Economy An increase in the supply of land (labor) leads to a biased expansion of production possibilities toward food(cloth) production a The biased effect of increases(decreases) In resources on production possibilities is the key to understanding how differences in resources give rise to international trade a An economy will tend to be relatively effective at producing goods that are intensive in the factors with which the country is relatively well-endowed Copyright C 2003 Pearson Education, Inc Slide 4-17
Copyright © 2003 Pearson Education, Inc. Slide 4-17 ▪ An increase in the supply of land (labor) leads to a biased expansion of production possibilities toward food (cloth) production. ▪ The biased effect of increases (decreases) in resources on production possibilities is the key to understanding how differences in resources give rise to international trade. ▪ An economy will tend to be relatively effective at producing goods that are intensive in the factors with which the country is relatively well-endowed. A Model of a Two-Factor Economy
Effects of International trade Between Two-Factor economies Assumptions of the Heckscher-Ohlin model There are two countries( Home and Foreign)that have Same tastes Sa ame technology Different resources Home has a higher ratio of labor to land than Foreign oes Each country has the same production structure of a two-factor economy Copyright C 2003 Pearson Education, Inc Slide 4-18
Copyright © 2003 Pearson Education, Inc. Slide 4-18 ▪ Assumptions of the Heckscher-Ohlin model: • There are two countries (Home and Foreign) that have: – Same tastes – Same technology – Different resources – Home has a higher ratio of labor to land than Foreign does • Each country has the same production structure of a two-factor economy. Effects of International Trade Between Two-Factor Economies
Effects of International trade Between Two-Factor economies Relative prices and the pattern of Trade ● FactorAbundance Home country is labor-abundant compared to Foreign country (and foreign is land-abundant compared to Home)ifand only if the ratio of the total amount of labor to the total amount of land available in home is greater than that in Foreign L/T>LITE acres, while britain has 20 million workers and 20 million e Example: if America has 80 million workers and 200 millio acres. then britain is labor-abundant and America is land abundant In this case. the scarce factor in home is land and in Foreign is labor Copyright C 2003 Pearson Education, Inc Slide 4-19
Copyright © 2003 Pearson Education, Inc. Slide 4-19 ▪ Relative Prices and the Pattern of Trade • Factor Abundance – Home country is labor-abundant compared to Foreign country (and Foreign is land-abundant compared to Home) if and only if the ratio of the total amount of labor to the total amount of land available in Home is greater than that in Foreign: L/T > L * / T * – Example: if America has 80 million workers and 200 million acres, while Britain has 20 million workers and 20 million acres, then Britain is labor-abundant and America is landabundant. – In this case, the scarce factor in Home is land and in Foreign is labor. Effects of International Trade Between Two-Factor Economies
Effects of International trade Between Two-Factor economies When Home and Foreign trade with each other, their relative prices converge. The relative price of cloth rises in Home and declines in Foreign In Home, the rise in the relative price of cloth leads to a rise in the production of cloth and a decline in relative consumption, so Home becomes an exporter of cloth and an importer of food Conversely, the decline in the relative price of cloth in Foreign leads it to become an importer of cloth and an exporter of food Copyright C 2003 Pearson Education, Inc Slide 4-20
Copyright © 2003 Pearson Education, Inc. Slide 4-20 • When Home and Foreign trade with each other, their relative prices converge. The relative price of cloth rises in Home and declines in Foreign. – In Home, the rise in the relative price of cloth leads to a rise in the production of cloth and a decline in relative consumption, so Home becomes an exporter of cloth and an importer of food. – Conversely, the decline in the relative price of cloth in Foreign leads it to become an importer of cloth and an exporter of food. Effects of International Trade Between Two-Factor Economies