Question

Countries A and B have two factors of​ production, capital and​ labor, with which they produce two​ goods, X and Y. Technology is the same in the two countries. X is​ capital-intensive; A is​ capital-abundant. Analyze the effects on the terms of trade and the welfare of the two countries of the​ following:

Event	Terms of trade effect	​A's welfare	​B's welfare
a. An increase in​ A's capital stock.	▼ A's improve A's worsen	▼ Increases Decreases Ambiguous	▼ Increases Decreases Ambiguous

Answer 1

As per Hecksher ohlin model, an economy will export the good in which it has a relative abundance.

Here,Country A will export good X to country B and import good Y

Terms of trade = Pexport/Pimport

An increase in A's capital stock will favor the production of Good X which will worsen the terms of trade for the exporting country as it improve the terms of trade of the trading partner.

A's terms of trade will worsen

A's welfare may increase so it's ambiguous

B's welfare increases