ECON 3601 Lecture 4: Lecture 4 - Chapter 5

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Lecture 4 ā€“ Chapter 5
Two-Factor Heckscher-Ohlin Model
1. Two countries: home and foreign.
2. Two goods: cloth and food.
3. Two factors of production: labor and capital.
4. The mix of labor and capital used varies across
goods.
5. The supply of labor and capital in each country is constant and varies across countries.
6. In the long run, both labor and capital can move across sectors, equalizing their returns
(wage and rental rate) across sectors.
Copyright Ā©2015 Pearson Education, Inc. All rights reserved. 5-5
Production Possibilities
ā€¢ With ī…µore than one factor of production, the opportunity cost in production is no
longer constant and the PPF is no longer astraight line. Why?
ā€¢ Nuī…µeriī„al eī‡†aī…µple:
K = 3000, total amount of capital available for production
L = 2000, total amount of labor available for Production
ā€¢ Suppose use a fixed mix of capital and labor in each sector.
aKC = 2, capital used to produce one yard of cloth
aLC = 2, labor used to produce one yard of cloth
aKF = 3, capital used to produce one calorie of food
aLF = 1, labor used to produce one calorie of food
Production possibilities are influenced by both capital and labor:
aKCQC + aKFQF ā‰¤ K
aLCQC + aLFQF ā‰¤ L
ā€¢ Coī…¶straint on capital that capital used cannot exceed supply:
ī®QC + īÆQF ā‰¤ īÆī¬ī¬ī¬
ā€¢ Coī…¶straiī…¶t on labor that labor used cannot exceed labor supply:
ī®QC + QF ā‰¤ ī®ī¬ī¬ī¬
Economy must produce subject to both constraints ā€“ i.e., it must have enough capital and labor.
ā€¢ Without faī„tor substitution, the production possibilities frontier is the interior of the
two factor constraints.
Max food production 1000 (point 1) fully uses capital, with excess labor.
ā€¢ Maī‡† ī„loth ī­000 (point 2) fully uses labor, with excess capital.
ā€¢ Iī…¶terseī„tioī…¶ of laī„or aī…¶d ī„apital ī„oī…¶straiī…¶ts occurs at 500 calories of food and 750 yards of
cloth (point 3).
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ā€¢ The opportuī…¶itī‡‡ ī„ost of producing one more yard of cloth, in terms of food, is not constant:
ā€“ low (2/3 in example) when the economy produces a low amount of cloth and a high amount
of food
ā€“ high (2 in example) when the economy produces a high amount of cloth and a low amount of
food
ā€¢ Whī‡‡? Beī„ause when the economy devotes more resources towards production of one good,
the marginal productivity of those resources tends to be low so that the opportunity cost is
high. The above PPF equations do not allow substitution of capital for labor in production.
ā€“ Unit factor requirements are constant along each line segment of the PPF.
ā€¢ If produī„ers ī„aī…¶ suī„stitute oī…¶e iī…¶put for aī…¶other iī…¶ the production process, then the PPF is
curved (bowed).
ā€“ Opportunity cost of cloth increases as producers make more cloth.
What does the country produce?
ā€¢ The eī„onomy produces at the point that maximizes the value of production, V.
ā€¢ Aī…¶ isoī‡€alue line is a line representing a constant value of production, V:
V = PC QC + PF QF
ā€“ where PC and PF are the prices of cloth and food.
ā€“ slope of isovalue line is ā€“ (PC /PF)
Given the relative price of cloth, the
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