Economics 1021A/B Study Guide - Quiz Guide: Factors Of Production, Opportunity Cost, Diminishing Returns
27 Oct 2018
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The Heckscher-Ohlin Model
The Heckscher-Ohlin Model focuses only on how differences in resources result in trade
between countries. Each factor of production can be used in each sector. This is more
realistic as most factors of production can be used to produce different goods. Especially
in the long run; people can acquire different skills, machines can be put to a different use,
and land can be changed.
Assumptions
1. Two countries: Home and Foreign.
2. Two factors of production: capital (K) and labor (L).
3. Two goods: cars (C) and food (F).
4. Same technology in the two countries.
5. Supply of labor and capital in each country is constant, but varies between countries.
6. Perfect competition in both sectors.
7. In the long run capital and labor can freely move across sectors, but there is no
international mobility of production factors ā rental rate (r) and wage (w)
equalization between sectors.
8. Cars production is labor-intensive and food production is capital-intensive.
One country
QC = QC(KC, LC) and QF = QF(KF, LF)
Diminishing returns to labor and capital ā Cobb-Douglas function.
The slope of the PPF = opportunity cost of cars in terms of food. A low MPL ā high
opportunity cost.
Value of production: V = PC x QC + PF x Q=
An isovalue line represents what combination of QC and QF result in the same constant
value of production, V* (given prices for the two goods).
QF = V*/PF ā (PC/PF) x QC
Slope = - PC/PF
If PC/PF > opportunity cost of cars in terms of food: produce more cars.
If PC/PF < opportunity cost of cars in terms of food: produce less cars.
Given the prices, the economy produces at the point Q that touches the highest possible
isovalue line. At that point, the relative price equals the slope of the PPF, which equals the
opportunity cost.
The output does not only depend on prices, but also on the wage (w) and the rental rate
(r). If w/r increases, producers use less labor and more capital in the production of both
food and cars.
Cars production is labor-intensive ā LC/KC > LF/KF at any price level.
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Document Summary
The heckscher-ohlin model focuses only on how differences in resources result in trade between countries. Each factor of production can be used in each sector. This is more realistic as most factors of production can be used to produce different goods. Especially in the long run; people can acquire different skills, machines can be put to a different use, and land can be changed. Qc = qc(kc, lc) and qf = qf(kf, lf) Diminishing returns to labor and capital cobb-douglas function. The slope of the ppf = opportunity cost of cars in terms of food. Value of production: v = pc x qc + pf x q= An isovalue line represents what combination of qc and qf result in the same constant value of production, v* (given prices for the two goods). If pc/pf > opportunity cost of cars in terms of food: produce more cars. If pc/pf < opportunity cost of cars in terms of food: produce less cars.
