Suppose that each unit of product A requires 4 workers and 1 unit of capital to

Question

Suppose that each unit of product A requires 4 workers and 1 unit of capital to produce, whereas each unit of product B requires 5 units of capital and 2 workers and that it is the case irrespective of prices (no factor substitution). All the other assumptions of the Heckscher-Ohlin model are satisfied. Suppose that in autarky the wage and rent each equal 100 in the England while in France the wage is 90 and the rent is 120.

(i) What does this indicated about the relative factor abundance of the two countries. Explain.

(ii) Suppose that England and France enter into free trade. The international price of product A is 550 and that of product B is 770. Both countries continue to produce both goods. What is the wage rate and the rental price in free trade? Show computations to get your answer.

Explanation / Answer

Let W be wage and R be cost of capital.

The cost of producing one unit of A:

4x100+1x100 =$500

The cost of producing one unit of B

5x90+ 2x120 =$670

The labor to cpaital rato of A

4

The labor to capital ratio of B:

5/2 =2.5

This means is A capital intensive and B is labor intensive.

(i) England is relatively Capital abundant than France. IN France capital is more expensive than Labor.

wage / rent = 1 in England

Wage / rent = 90/120 = 0.75 in France

(ii) As England is relatively cheaper in using capital than France, Enland will produce product A and France will produce Product B.

The intenretion wage rate and rent can be found by equating the internation price as follows:

4W+1R = 550

R = 550-4W

5W+2R = 770

5W+2(550-4W) = 770

3W = 330

W= $110

R = 550-4x110

R = $100

SOlving the equations we get

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