International Trade
Dadoboeva F.
New Classical Theories of
International Trade
New Classical Theories of International Trade

Specific Factor Model

Factor Endowment Theory (H-O Model)

Other New Classical Theories

Leontief Paradox
Specific Factor Model

The specific factor model is to analyze the effect
of a change in commodity price on the returns of
factors in a country when at least one factor is not
mobile between industries.
It
indicates that workers may be better or worse off,
depending on preferences;
It predicts that owners of factors used in export
industries gain from trade, while owners of factors
used in import-competing industries will lose from
trade.
Specific Factor Model

specific factor
Its
use is specific to either the production of machines
or the production of cloth and cannot move between
industries.
 Such as capital in the model.

mobile factor
It
can move between machine production and cloth
production over time.
 Such as labor in the model.
Specific Factor Model
Wage
Rate
Wage
Rate
F
W1
W0
W0
DC
O
W1
E
L
L1
Total Labor Supply
of the U.S.
DM’
DM
O’
DM : the machine industry’s
demand for labor.
DC : the cloth industry’s
demand for labor
W0 : equilibrium wage,
which occurs when OL
labor is employed in the
machine industry and
O’L labor is employed in
the cloth industry.
As the demand for labor in the
machine industries increases,
the wage rate rises and
workers move from the cloth
industries to the machine
industries.
Specific Factor Model

The existence of specific factors can help explain
why some groups resist free trade.
In general, owners of the abundant factor of
production in a country should be in favor of
free trade.
However, both capital and labor in the industry
with a comparative disadvantage suffer losses
and may well resist free trade.
Factor Endowment Theory (H-O Model)

The Ricardian principle of comparative
advantage explains why specialization and trade
lead to gains for producers and consumers.
 It does not, however, in itself explain why the
production possibilities frontiers (PPF) of
different countries have different shapes, and
thus why a country’s comparative advantage is
in one product rather than another.
Factor Endowment Theory (H-O Model)

The factor-endowment theory states that
comparative advantage is explained exclusively
by differences in relative national supply
conditions.
 In particular, the theory highlights the role of
countries’ resource endowments (such as labor
and capital) as the key determinant of
comparative advantage.
Factor Endowment Theory (H-O Model)

Assumptions

Countries all have the same tastes and
preferences (the same indifference curves);
They use factor inputs which are of uniform
quality;
They all use the same technology.
Factor Endowment Theory (H-O Model)
Wheat
France’s PPF
Wheat
30
F
France’s PPF
F’
21
G
15
F
20
II
Ⅰ
tG
H
G
10
G’
II
Germany’s PPF
tF
Germany’s PPF
t1
0
14
20
Auto
0
6
18
30
Auto
Factor Endowment Theory (H-O Model)

In summary, the factor endowment model asserts
that the pattern of trade is explained by
differentials in resource endowments.
A
capital abundant country will have a comparative
advantage in a capital-intensive product;
While a labor abundant country will have a
comparative advantage in a labor-intensive product.
Factor Endowment Theory (H-O Model)
 Implications
Factor
price equalization
The shift within each country towards use of
cheaper factors, and away from expensive
ones, leads to more equal factor prices (if
factors are mobile).
Distribution of income
Trade changes domestic distribution of
income as demand for different factors
changes.
Other New Classical Theories

Rybczynski Theorem

It basically says that the way in which a country grows
has an impact on the production and trade mixes of the
country.
 Countries with low savings rates that invest little in
new plants and equipment will tend to produce and
trade labor-intensive goods.
 Countries with high savings and investment rates
will tend to produce and trade more capitalintensive goods.
Other New Classical Theories
T
ρ
T0
T1
ρ
X0
S0
X1
S1
The Effect of an Increase
in Country A’s Capital Stock
S
At constant world prices,
if a country experiences
an increase in the supply
of one factor, it will
produce more of the
product whose
production is intensive in
that factor and less of the
other product.
Other New Classical Theories

Factor Price Equalization Theory
Free international trade will lead to equalization
of in the returns to homogeneous or identical
factors across.
The theory predicts that some factor payments
will rise and others fall with the introduction of
trade.
Other New Classical Theories
Given
all the assumptions of the H-O model, free
international trade will lead to the international
equalization of individual factor prices.
 In countries that have high wages before trade
begins, there will be tendency for wages to fall.
 In countries with initially low wages, trade will
produce tendency for wages to rise.
 Under the strict assumptions of the H-O model,
these tendencies will continue until the equalization
of wages is achieved. The same will be true for
rental rates on capital.
Other New Classical Theories

Stolper-Samuelson Theorem
Free
international trade benefits the abundant factor and
harms the scarce factor.
 Wages
initially high in Country A because labor is relatively
scarce and hence can exploit its scarcity power in the factor
market.
 International trade means manufacturers using scarce labor in
Country A must now compete with manufacturers using more
abundant labor in Country B.
 International competitive pressures tend to force down wages in
Country A.
 Thus, even though labor is immobile between countries, its
price is equalized through competitive bidding for its services.
Other New Classical Theories
Implications
 First,
we now have established a reason for some
groups in a community to oppose in international
trade.
 Second, the Stolper-Samuelson theorem provides
insights into why governments may impose barriers
to trade.
 Finally, it is important to remember that even
though some interest groups lose from international
trade, the country as a whole gains from
international trade relative to autarky.
Other New Classical Theories

Explaining Wage Inequality
Wage Ratio
S2
S0
S1
2.5
2.0
1.5
D1
D0
O
1.5
2.0
2.5
Labor Ratio
Other New Classical Theories

A shift in either the supply curve or demand
curve of skilled workers available relative to
unskilled workers will induce a change in the
equilibrium wage ratio.
 Factors can affect wage inequality.
International
trade and technological change
Immigration
Education
and training
Leontief Paradox

According to the H-O model ,the United
States should export capital-intensive goods
and import labor-intensive goods.
 Leontief’s experiment found was exactly the
opposite of the H-O model. According to
Leontief’s experiment, U.S. exports tend to
be labor intensive relative to U.S. imports.
 Attempted Reconciliations of Leontief’s
Findings.