Suppose Australia is a capital (K)-abundant country, and Sri-Lanka is a labor (L

Question

Suppose Australia is a capital (K)-abundant country, and Sri-Lanka is a labor (L)-abundant country. Both produce labor and capital intensive goods with the same technology. The production of food is capital intensive, and that of cloth is labor intensive. Use Heckscher-Ohlin model to answer the following questions:

a. Which of the two countries has a higher relative wage, w/r, before trade?

b. Which product is the labor intensive, and which is the capital intensive one?

c. What happens to the relative price of cloth in Australia as a result of trade? Does it increase or decrease?

d. Which country will export cloth as a result of trade?

e. What happens to the relative income of workers in Australia as a result of trade? Does it increase or decrease?

f. Would land owners in Australia lobby for or against free trade?

g. Would land owners in Australia lobby for or against free admittance of immigrant workers?

Explanation / Answer

The Heckscher-Ohlin Theory predicts that a country will export the product which uses the factor in which it is heavily endowed. And will import the product which uses the factor in which it is less abundant. The basic postulate of Heckscher-Ohlin Theory suggests that labor–abundant countries tends to produce labor–intensive products and capital abundant countries produce capital–abundant products. It also suggests that the country exports the product that uses its relatively abundant factor.

Given that

a) Relative wages are higher in the country with fewer labor resources, that is, Australia

b) The production of food is capital intensive, and that of cloth is labor intensive

c) As a result of trade, Australia will produce (and export food). Hence the relative price of food rises

d) Since Sri-Lanka is a labor (L)-abundant country and production of cloth is labor intensive, Sri Lanka will export cloth.

e) As a result of trade, Australian capital owners gain from trade while labor/workers loose since their production and the relative price (wages) have fallen.

f) Land owners in Australia lobby for free trade as their income will rise

g) Land owners in Australia would lobby for free admittance of immigrant workers into Australia. The reason is that the productivity of labor is high in Australia and capital owners have much economic rents to gain from an inflow of workers.

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