There are two countries (Germany and France), two factors of production (labor a
ID: 1110917 • Letter: T
Question
There are two countries (Germany and France), two factors of production (labor and capital) and two goods (Cars and Wine). Suppose that when trade is opened up between Germany and France, Germany starts to import Wine, which is labor intensive in production.
a. If you apply the Heckscher-Ohlin theorem, is Germany capital-abundant or labor abundan? Briefly explain why.
b. What is the expected impact on the real wage of labor in Germany? Briefly explain.
c. What group (capital or labor) in Germany would be expected to support policies to limit free trade?
Explanation / Answer
(a) As per Hecksher-Ohlin model, the labor abundant country exports the labor intensive good (and imports the capital intensive good), and the capital abundant country exports the capital intensive good (and imports the labor intensive good). Since Germany imports the labor intensive good, Germany is capital abundant.
(b) Since labor intensive good is getting imported rather than being domestically produced in Germany, demand for labor falls in Germany, leading to a decrease in real wage of labor.
(c) Limitation of free trade will decrease import. Therefore, import of the labor intensive good (wine) will fall, leading to higher domestic demand for wine which will increase the demand for labor, resulting in higher wage rate. Therefore the Labor group will support policies to limit free trade.