Ricardian Model and Heckscher Ohlin Model - Assignment Example

Question Ricardian model is a ical theory of international trade that explains how two commodities are traded in two countries. According to this theory, Ricardo assumed that there is one factor of production that is fixed and the economy is characterized by two commodities, which have almost, identical marginal factor and average output ratios in the production process. Furthermore, Ricardo assumed that the demand function normally and each country spend an equal amount of income. Moreover, the model presumes that there is a trade between two countries trading two goods and disregarding the cost of transport. The model assumes that international transports costs are immobile. Lastly, the Recardian model functions in a perfect competition where there is no barrier of entry or control by government agencies (Bhagwati, Panagariya, & Srinivasan 9). Recardian model argues that trade is as a result of difference in the production technologies. Therefore, other factors that affect production and trade are assumed to be similar across countries. Ricardo model is an advantageous, and it is necessitated by differences in technologies. Unlike other model that propose that trade benefit some people and leave other people disadvantaged, Recardian model argues that all parties involved in free trade could benefit from it. This can be explained by a national indifference curves or computation of workers real wages. However, this is made possible because the model assume labor as the only factor of production (Pomfret 10). Ricardo constructed a universal equilibrium model. His model describes a complete flow of resources in the exchange of services and goods. The trades of goods generate revenue which firms use it to pay factors of production (labor). The workers, in turn, use their income from labor to buy goods made by local firms or from internationals companies abroad. Ricardian model argues that free trade give absolute advantage to both countries that are engaged in international trade. He argues that even the country with an inferior technology gain from trading with a country with superior technology. Ricardo coined the term comparative advantage to mean production of goods at a lower opportunity cost than other countries. This enables such a country to compete competitive in international trade because it produces goods at a lower cost. Ricardo suggested that countries should engage in production of goods that they have a comparative advantage to as to achieve a higher level of consumption and better living standard. Comparative advantage calls countries to specialize in the production. For this reason, the two countries in Ricardian model benefit tremendously from trade (Pomfret 21). Apart from comparative advantage, the absolute advantage determines the extent of gain countries get from an international trade. It is the production of goods at relative lower costs than other countries. It compares productivities of industries across countries engaging each other in international trade. Ricardian model assumes that countries differ in production technology, and this difference enables countries with absolute advantage over other to specialize in that line. Therefore, when country specialize in productions of goods and services they have an absolute advantage than the production of goods increases for both countries. Question 2 Heckscher Ohlin (HO) model explains the reason for international trade. The model assumes that the reason country engaged in trade is because differently countries have different natural resources. The Heckscher Ohlin model contrasts Ricardian model. This model was developed soon after the end of the ‘golden age’ (Feenstra 88). During this time, there was growth in the transportation industry that made an outstanding deal in increasing the international trade. The majority of the country in the world experienced growth and expansion of trade in late 18th century. Heckscher and Ohlin offered to explain the increase in trade and thus the Heckscher- Ohlin model (Feenstra 88). The model assume that trade is between two countries, a Foreign and Home country and which produces two sets of goods, example shoes and computers. Moreover, the production comprises of two factors, capital and labor. The HO assumes that both factors of production, capital and labor can move from one industry to another freely without any difficulties. This assumption argues that industries that are efficient in production and have a higher return on capital investment rent attract capital from other industries leading to their closure. However, if industries, shoes and computer industries produce similar rentals, then the labor factor earned should be the same in both industries (Feenstra 89). Heckscher also assumes that the production is labor intensive, or capital intensive. Therefore, where the industry uses more labor, then the industry is said to be a labor intensive industry. On the other hand, computer production is capital intensive and requires more capital than labor and thus it is a capital intensive industry (Feenstra 89). The above assumption discusses factors within a country, but HO model also focus on the assumption that cut across countries as well as within the country. The other assumption is that there is profuse foreign labor. This means that labor to capital ratio exceeded in the foreign country than in home country. According to HO model, countries differ in territorial size and their population. Moreover, countries are in dissimilar stages of progress and so are they differ in capital endowment. This different explains why countries engage in international trade (Feenstra 90). In the short run HO model assume that labor and capital are immobile, but in the long run the model relaxes this assumption and country trade while labor and capital are mobile. However, in the short run and long run there is free movement of goods and services and the market for these goods is perfect competition. Heckscher Ohlin model assumes that the two countries that are in trade with each other uses identical technology in production of goods. This assumption differs with Ricardian model that suggested country trade with each other because they differ in technology production. Heckscher assumption of similar technology is not realistic, but help in explaining the reason for trade as envisioned by Heckscher and Ohlin. The HO model also assumes that both countries that are trading together have similar tastes and preferences even if they belong to a different level of income. According to this assumption Heckscher assumed that people in a poor country would buy fewer shoes at the same price rich countries are buying ,but consumers in a developing country tend to spend more on shoes and clothing while richer nation spend on computers and electronics more than on clothing(Feenstra 91). a) Feenstra says that trade is determined by the abundance of factor of productions. A country that has labor abundance will export goods that require labor intensive in the production process. Therefore, such a country will export goods its produces and import those that it has limited factor such as capital (98). b) The HO model argues says revenue collected from international trade is used to pay wages and rent. Therefore, what a country get after exporting goods such as shoes is spent in importing computers and other electronics. Firms and individuals both uses their profits and wages to pay for import goods and this way wages and profits have a tendency to equalize. c) The assumption that country has different technology and that the taste and preferences of people is different would lead to the falsification of the Heckscher Ohlin model. Question 3 a) Tariff imposed on a small country has no effect on the world prices of the product. However, the policy shifts the sully curve of export upwards. The demand decreases while quantity supplied increases. Nevertheless, the marginal costs of producing an extra commodity also rise. Higher tariff has an unconstructive shock on real income. Moreover, the interference of free trade contributes to inefficiency in resource allocation. One of the key advantages of free trade is that it ensures resources are distributed equally. Therefore, tariff makes the market for imported goods an imperfect market (Feenstra 2). b) Tariff imposed on goods in a ‘small’ country has the effect of increasing the price of goods. Increase of price of goods requires that consumers spend more of their income buying imported goods and thus consumer surplus fell. Therefore, tariff reduces the welfare of the people. The consumer surplus loss equal (a+b+c+d) which is due to the introduction of tariff by the government of a small country (Feenstra 15). Introduction of quotas and export subsidies expound on the protectionism of local firms by small countries. Quota also amount to interfering with the forces of demand and supply in international trade. Therefore, they as ‘the invisible hand’ that Smith talked about when he discredited government involved in trade. Subsidy refers to government payment to firm involved in exportation of goods by offering them favorable condition to enable them competes in the international market. They distort the market by hindering efficient distribution of resources. Moreover, subsidies and quotas deny consumers the best goods from the market. Free trade allows the most efficient firm to survive while the inefficient shutdown due to the high cost of production. Question 4 Proponents of protectionism argue that it is the duty of a country leadership to protect it interest against the interest of other foreign countries. They say that infant industries cannot afford competition of well established international companies. Moreover, firm require time to learn and gain expertise as do people when starting on their careers. Therefore, it is wrong to expose new industries at home to free trade because other firms are more experienced. Infant industries need protection to enable them competes favorably and to give them time to mature (Gottheil 394). Free trade enables firm seek labor from any part of the world. This has it detriment to a certain country, and some scholar argues against free trade in this regard. The issues of cheap labor affect the American firms even to this day. The unionized firms pay high wages to their labor force and incur enormous part of the revenue in labor related expenses. Therefore, goods produced by these firms are always expensive compared to goods from China, Jamaica and other country that has cheap labor (Gottheil 394). Import form these countries are cheaper and the competition for market share are always to their advantage. To protect against cheap foreign labor, it is beneficial to disregard free trade. Developed country produce goods that they have a comparative advantage such as primary goods leaving agriculture because it has low income elasticity. They there propose that free trade is all that the world requires increasing productivity of every nation that participates in international trade. However, developing nations are disadvantaged because the main activity is agriculture. Therefore, in order to diversify the developing country need to shun away proponent of free trade (Gottheil 394). Work Cited Bhagwati, J. N., panagariya, A., & Srinivasan, N. Lecture on International Trade. 1998. Massachusetts. Massachusetts Institute of Technology. Print. Feenstra, Taylor. Import Tariffs and Quotas under Perfect Competition.Web. 14 Feb. 2014. < http://www.palgrave.com/PDFs/0716799049.pdf>. Feenstra, Taylor. Trade and Resources: The Heckscher-Ohlin model.2010. New York. Worth Publishers.Print. Gottheil, Fred. Principles of Macroeconomics.2013. London. Cengage Learning. Print. Pomfret, Richard. Lecture Notes on International Trade Theory and Policy. 2008. Singapore. World Scientific Publishing. Print. Read More