Carefully explain, for each of the following two statements, why the statement i
ID: 1169291 • Letter: C
Question
Carefully explain, for each of the following two statements, why the statement is either TRUE or FALSE.
(a) "In a 2x2x2 Heckscher-Ohlin context, when a relatively labor-abundant country moves from autarky to trade, the real return to capital in the import-competing industry decreases and the real return to capital in the export industry also decreases."
(b) "In the ‘specific-factors model,' with capital fixed in each sector, when a relatively labor-abundant country moves from autarky to trade, the real return to capital in the import-competing industry decreases and the real return to capital in the export industry also decreases."
Explanation / Answer
(a)
The Hecksher-Ohlin model hypothesizes that comparative advantage is based on national difference in factor endowments. Countries exports goods that have production requirement that are intensive in the nation’s relatively abundant factor. They imports good that require intensive input from the nation’s relatively scarce factors. The H-O model implies that the income of the abundant factor rises with the opening of the trade and it falls for the scarce factor.
If country A has comparative advantage in production of steel which uses its more abundant factor capital, as trade opens the demand for capital increases in the country while the demand for labor falls. The laid off labor in bread factories is picked up by steel industry but not at the rate it’s laid off. Thus, the end result is a decline in the factor income and demand for labor. Thus, as trade begins the demand for capital increases and the return to that factor increases and their income. The demand or labor falls and thus return to the factor and their income.
Therefore, the statement is TRUE.
(b)
In the specific factor model, each good is produced with a specific factor, whose only use is in the production of that good, and a variable factor, which is used to produce both goods. The specific factors are immobile and cannot move between goods, while the variable factor is completely mobile between industries. Countries exports goods that have production requirement that are intensive in the nation’s relatively abundant factor. They imports good that require intensive input from the nation’s relatively scarce factors.
At the time trade opens, each country follows its comparative advantage and moves towards greater specialization. The shift in production alters the demand for the specific factor that is used in the industry that shrinks. In each country, the specific factor in the declining industry experiences a fall in income.
Suppose county A's cuts back on steel production in order to concentrate on bread, which it exports for steel. country A's owners of capital in steel sector are hurt, since the structure of the economy changes from production of capital intensive steel, while country A's capital owners in bread sector experience precisely the opposite effect. Their incomes rise as the demand for capital to produce bread export rises.
Therefore, the statement is FALSE.