Consider the typical HO setting: 2 countries, Colombia and Venezuela, produce tw
ID: 1153258 • Letter: C
Question
Consider the typical HO setting: 2 countries, Colombia and Venezuela, produce two goods, manufactures and bread, with two factors, capital and labor. Both countries share the same tastes and the same technology. Manufactures’ production is capital intensive. In Colombia there are 200 units of labor and 200 of capital, in Venezuela there are 40 units of labor and 100 of capital.
1) With respect to factor abundancy, which of the following is true
Venezuela is both capital abundant and labor abundant, and Colombia is neither.
2.
In autarky, the wage – rental ratio (w/r) is
3. In free trade,
a.Colombia is labor abundant and Venezuela is capital abundantExplanation / Answer
1. The basis of Heckscher Ohlin Theory of international trade is the Ricardian Comparative cost advantage theory. The Ricardian theory states that countries trade with each other on account of the comparative cost difference in production. But his theory fails to explain how the comparative cost difference arises.
Heckscher explains the root cause of this difference in comparative cost. He did not fully reject the Ricardian theory of comparative cost. Further he elaborated the classical theory by adding the reason of the difference in comparative cost.
Heckscher states that international trade result from the difference in relative prices of commodities in different countries. The relative prices differ due to the difference in factor prices. The reason of difference in factor prices is the difference in factor endowments.
To conclude in Heckscher Ohlin theory the basis of international trade is the difference in factor endowments. Thus Ohlin theory is otherwise known as the facto endowment theory of international trade.
The factor endowments can be decided on the basis of factor price and physical quantity of factor used.
By considering factor price Colombia is said to be a capital abundant country if the price of capital is lower in Colombia than Venezuela.
In other words (PK/PL) Colombia < (PK/PL Venezuela. Here P stands for price, K for capital and L for labour. It means that the relative price of Capital in Colombia is cheaper than Venezuela.
The facto abundance can be proved in terms of physical quantity. A Colombia is said to be factor abundant if it uses larger proportion of capital to labour compared to other country.
(K/L) Colombia > (K/L) Venezuela.
On the basis of factor price and the physical quantity of factor used:
Answer. C. Colombia is both capital abundant and labour abundant and Venezuela is neither.
2. The wage rental ratio (w/r) is lower in Colombia than in Venezuela.
Answer b. lower in Colombia than in Venezuela.
3. Here production of bread is labour intensive and the production of manufacture is capital intensive. As per the physical quantity and price criterion the labour is cheap in Colombia than Venezuela. Therefore Colombia can produce bread at a cheaper rate than Venezuela. Thus under free trade Colombia will export bread.
Answer. a. Colombia will export bread
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