ECO2/3ITR International Trade - Assignment 2

Question 3 – The Heckscher-Ohlin Model of Trade

10 marks (3+3+1+3)

Assume two economies Germany (GER) and Cambodia (CAM) produce cars (C) and rice (R) using two factors, capital (K) and labour (L), which are mobile across sectors. Cars production is capital intensive and rice production is labour intensive. Further, Germany has 120 units of labour and 120 units of capital, while Cambodia has 100 units of labour and 80 units of capital. The cost of labour is w. The cost of capital is r.

1. (3 marks) Which country is capital abundant relative to the other country? Explain why.
2. (3 marks) In the diagram below, draw the relative supply of cars/rice for each country in autarky. Explain any difference across countries. (Hint: Remember that relative prices reflect opportunity costs).
   Now, suppose Germany and Cambodia are free to trade.
3. (1 mark) In the graph depicted in point (b) above mark the approximate relative price under free trade. Describe the patterns of specialisation and trade.
4. (3 marks) At free trade relative price, does Germany produce more or fewer cars relative to rice in comparison with autarky? Does Cambodia produce more or fewer cars relative to rice in comparison to autarky? Mark these points of production at free trade price on the graph depicted in point (b).