International Economic RelationsEcon 548 Summer 2007

William J. PolleyDepartment of Economics

College of Business and TechnologyWestern Illinois University

Trade theory through the years…

Mercantilism Adam Smith David Ricardo

Comparative advantage Heckscher-Ohlin Theorem More recent developments

Heckscher-Ohlin

Assumptions 2 countries, 2 goods (sectors), 2 factors Factors are in fixed amounts, mobile across

sectors, immobile across countries Identical consumer tastes and production

technologies Constant returns to scale

Heckscher-Ohlin

Theorem: A country has a comparative advantage in the good that makes relatively intensive use of the relatively abundant factor.

Factor Price Equalization

Under HO assumptions, free trade induces equalization of wages and capital rental rates across countries.

Stolper-Samuelson Theorem

An increase in the price of the labor intensive good will increase the wage relative to the prices of both goods and reduce the capital rental rate relative to the prices of both goods.

The reverse is also true.

Rybczynski Theorem

Given prices, an increase in labor will increase output of the labor intensive good more than proportionally and reduce the output of the capital intensive good.

Similarly for an increase in capital.