Question

Consider a Heckscher- Ohlin model with two countries, Home and Foreign, two goods, tomatoes and wheat, and two factors of production, labor and land. Countries have identical technologies, so that a unit of tomatoes takes 10 hours of labor and 5 acres of land, and a unit of wheat takes 4 hours of labor and 8 acres of land. Assume Home has 100 hours of labor and 80 acres of land, while Foreign has 60 hours of labor and 40 acres of land.

g) With the opening of trade, towards which direction do home wages and rental rates move? Which theorem do you use?

h) Does everyone in Home gain under free trade? Explain.

Answer 1

g) with opening trade the wages and rents will be equalised according to the factor price equalisation theorem. as the factor price equalisation theorem states, free trade equalises the factor price in the long run and this happens because abundant factor of production is demanded in large quantity so there price or we can say factor price increases.

h) under free trade both the countrys abundant factor of production which is demanded most will get benifitted the most but the rare factor of production will loss as there will be import taking place from the trading partner.