Application Letter

Topics: International trade, Economics, Neoclassical economics Pages: 5 (1728 words) Published: September 16, 2013
Adam Smith's model
Adam Smith displays trade taking place on the basis of countries exercising absolute advantage over one another. Ricardian model
The law of comparative advantage was first proposed by David Ricardo. The Ricardian model focuses on comparative advantage, which arises due to differences in technology or natural resources. The Ricardian model does not directly consider factor endowments, such as the relative amounts of labor and capital within a country. The Ricardian model makes the following assumptions:

1. Labor is the only primary input to production
2. The relative ratios of labor at which the production of one good can be traded off for another differ between countries and governments Heckscher-Ohlin model
Main article: Heckscher-Ohlin model
In the early 1900s a theory of international trade was developed by two Swedish economists, Eli Heckscher and Bertil Ohlin. This theory has subsequently been known as the Heckscher-Ohlin model (H-O model). The results of the H-O model are that countries will produce and export goods that require resources (factors) which are relatively abundant and import goods that require resources which are in relative short supply. In the Heckscher-Ohlin model the pattern of international trade is determined by differences in factor endowments. It predicts that countries will export those goods that make intensive use of locally abundant factors and will import goods that make intensive use of factors that are locally scarce. Empirical problems with the H-O model, such as the Leontief paradox, were noted in empirical tests by Wassily Leontief who found that the United States tended to export labor-intensive goods despite having an abundance of capital. The H-O model makes the following core assumptions:

1. Labor and capital flow freely between sectors
2. The amount of labor and capital in two countries differ (difference in endowments) 3. Technology is the same among countries (a long-term assumption) 4. Tastes are the same.
Reality and Applicability of the Heckscher-Ohlin Model
In 1953, Wassily Leontief published a study in which he tested the validity of the Heckscher-Ohlin theory.[5] The study showed that the U.S was more abundant in capital compared to other countries, therefore the U.S would export capital-intensive goods and import labor-intensive goods. Leontief found out that the U.S's exports were less capital intensive than its imports. After the appearance of Leontief's paradox, many researchers tried to save the Heckscher-Ohlin theory, either by new methods of measurement, or by new interpretations. Leamer[6] emphasized that Leontief did not interpret H-O theory properly and claimed that with a right interpretation, the paradox did not occur. Brecher and Choudri[7] found that, if Leamer was right, the American workers' consumption per head should be lower than the workers' world average consumption.[8][9] Many textbook writers, including Krugman and Obstfeld and Bowen, Hollander and Viane, are negative about the validity of H-O model.[10][11] After examining the long history of empirical research, Bowen, Hollander and Viane concluded: "Recent tests of the factor abundance theory [H-O theory and its developed form into many-commodity and many-factor case] that directly examine the H-O-V equations also indicate the rejection of the theory."[11]:321 In the specific factors model, labor mobility among industries is possible while capital is assumed to be immobile in the short run. Thus, this model can be interpreted as a short-run version of the Heckscher-Ohlin model. The "specific factors" name refers to the assumption that in the short run, specific factors of production such as physical capital are not easily transferable between industries. The theory suggests that if there is an increase in the price of a good, the owners of the factor of production specific to that good will profit in real terms. Additionally, owners of opposing...
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