Question

Show answer in graphs and explain the following:

In a two country model with two goods and two factors, both countries have identical endowments of capital and labour, as well as the homothetic tastes. There are, however, international technological differences of the Hicks- neutral variety. When two countries are in free trade equilibrium, both are incompletely specialized in production, and the wage/rental ratio is higher in the foreign than in the home country. Which country exports the labour- intensive good in this equilibrium?

Answer 1

Solution:-

As per the Heckscher-Ohlin model, a labor-abundant country will export labor-intensive good. A higher wage-rental ratio means that labor is relatively more expensive. In response to this, firms will demand capital and become capital abundant and according to the value definition of a factor, abundance country will export capital-intensive good. So, a home will export labor-intensive good.

Given that wage/rental ratio is higher in the foreign than in the home country. Relative costs of labor is higher in foreign country and thus relative prices of labor intensive good is also higher.

Thus home exports the labor-intensive good , as relative cost of labor is less ( principle of comparative advantage)