Classical Trade Model And Factor Intensity Economics Essay

The Ricardian theoretical account ‘s chief focal point is on comparative advantage, one of the most cardinal thoughts in international trade theory. This theory states that states should specialise in the production of what they produce best, therefore wholly specialising alternatively of bring forthing a broad assortment of goods. The neo classical theoretical account or Heckcher-Ohlin theory differs from this, it stresses that states should bring forth and export goods that require factors that are copiously available. This theory so differs from those premises of comparative and absolute advantage since they merely focus on the productiveness of the production of a good. On the other manus, the Heckcher-Ohlin theory provinces that a state should concentrate production and exports based on the factors that are copiously available to them and therefore the cheapest to bring forth.

The chief thought of the theoretical account Centre ‘s itself around the differences in factor gift, the fluctuations of factors ( Land, Labour, Capital and Entrepreneurship ) that a state have and can so do usage of for fabrication. These factors of production determine a states comparative advantage, so a state so has a comparative advantage in the goods that are richly local and available to them, this so allows for trade flow. A state must besides take into consideration costs, if a good requires local inputs that are copiously available to that state so production is traveling to be cheaper, instead than prosecuting in the production of goods that are locally scarce. This introduces the construct of factor strength, where manufacturers use different ratios of factors of production in order to bring forth different goods. A state has been seen to utilize this construct if that state has a comparative advantage in a good whose production is intensive in the factors that are abundantly available. To exemplify an illustration we could take oil refinement for case, this can be said to be capital intensive as it is expensive to bring forth, on the contrary if we take the production of vesture as an illustration this can be said to be labour intensive.

To sketch this factor copiousness theory, and give a better apprehension of its chief characteristics we can look at its general structure/assumptions made:

General Structure/assumptions of Neo Classical Model ( Factor Abundance Theory )[ 1 ]

2 ten 2 ten 2 theoretical account ( two states, two concluding goods, two factors of production capital and labor )

This theoretical account has variable factor proportions between states: so that states which are highly developed have a relatively high ratio of capital to labor in relation to developing states. This so makes the developed state capital intense/abundant relation to the developing state, and makes the underdeveloped state labour intense/abundant relation to the developed state.

Changeless returns to scale: dual input = dual end product ( X = 2, Y = 4 )

Identical Production engineering everyplace

Input factors capital and labor ( K & A ; L ) are nomadic between sectors, but non between states.

All markets characterized by perfect competition, no barriers for trade, and no conveyance costs.

Demand construction is the same, homothetic penchants

Available sum of factors of production may differ ( gift may differ ) . These differences in factor copiousness will give rise to international trade flows.

Main Results of Neo Classical Trade Theory[ 2 ]

These premises have given light to certain named decisions, and have formed the chief consequences of the neo classical trade theoretical account. They are as follows:

Factor Price Equalization Theorem

International trade of goods between two states leads to an equalization of the wagess of the factors of production the two states. E.g. equal in capital rental rate ( workers in each state are paid the same )

Stopler – Samuelson Theorem

An addition in the monetary value of a concluding good increases the wages to the factors of production, used intensively in the production of that good. E.g. if the monetary value of a concluding good ( paper ) increases, so the monetary value of wood would besides increase

Rybczynski Theorem

An addition in the supply in a factor of production ( K, L ) consequences in the addition in the end product of the concluding good that uses this factor of production comparatively intensively. E.g. workers used intensively so will therefore consequence in an addition of end product.

Heckscher – Ohlin Theorem

A state will export the good which intensively uses the comparatively abundant factor of production.

In undertaking this inquiry as to why Marks and Spencer may exchange fabrication to a less developed state, the chief focal point will be upon the Factor Equalisation Theorem. This theorem suggests that when the monetary values of the end product goods in this instance vesture are equalised between states as they come closer to merchandise, so the monetary values of the factors ( capital and labor ) will besides be equalised between states. This equalization happens as a consequence of the states being monetary value takers due to perfect competition. Ohlin makes it clear that he himself did non really think that the wagess for the factors of production would b equalised between two states, merely that there is likeliness that they would go more equal.[ 3 ]This becomes apprehensible when we know that the factors of production that are in copiousness in one state are scarce in the other.

Monetary values are equalised due to the premise of perfect competition, if markets for vesture were unfastened on the international market, the monetary values that they charge for vesture will be the same in both states. Because of this ground, the factors of production will besides be the same for both states. In relation to the inquiry, based on the factor equalization theorem, production can exchange to a different state entirely on the construct of factor strength. Traveling production to a less developed state may be because labor is abundant in that state, hence more efficient in the production of vesture. Even though both states produce the same end product at the same pay rate, there are differing sums of capital and labor being used. To separate the sums of labor and capital used we use the isoquant/isocost model that is derived from the Cobb Douglas production map.

Cobb Douglas Production Function

Y = KyI±y Ly1-I±y

Y – Production degree of end product Y

K – Sum of capital used in fabrication sector

L – Sum of labor used in fabrication sector

I±y – parametric quantities ( step of capital strength )

This equation allows the permutation of one input for another, that is to bring forth the same degree of end product with different combinations of inputs, in rule ; an infinite figure of possibilities are available in order to bring forth the same degree of end product. We can besides organize an Isoquant graphical figure which is derived from this map ; in unit footings the Cobb Douglas becomes the isoquant.

Figure 1 shows an isoquant, which depicts all possible efficient combination of capital and labor able to bring forth giving the same degree of end product. Taking into history the construct of factor strength, the state wants to bring forth utilizing the factor that is copiously available to them giving them purchase and doing production more efficient on their portion. Figure 2 shows the same isoquant but with the isocost lines added. Because we are looking at the production of vesture, which is labour intensive, we would prefer to be utilizing labour as the chief factor of production, significance we would desire a new optimum point ( point B ) where more labor is used than capital. Figure 2 shows this alteration in optimality doing the isocost line flatter, the first move is that the isocost line pivots/rotates due to a lower pay rate, secondly it moves parallel until intersection point ( becomes tangent ) and shifts down until new optimum point ( point B ) at lower pay rate. Indicate A shows the point where capital is high ( capital intensifier ) , and point B is the complete antonym where labor is high ( labour intensifier ) . At point B, the production of vesture in the underdeveloped state is efficient and best suited as it is a labour intensive state.

To reason I will give the restrictions of the theoretical account and so travel on to associate the inquiry and theoretical account in existent life footings.

Limitations/Criticisms of theoretical account

Lieontief paradox – argues with the chief propositions made.

Found that the US, despite holding a comparative copiousness of capital, tended to export labour intensive goods and import capital intensive goods.

That engineering is the same

The factor equalisation theorem applies merely for most advanced states. Wage disagreements are non usually in the range of the H-O theoretical account analysis

Identical production map

The standard Heckscher-Ohlin theoretical account assumes that the production maps are indistinguishable for all states concerned. This means that all states are in the same degree of production and have the same engineering. This is extremely unrealistic.

No unemployment

Unemployment is the critical inquiry in any trade struggle. Heckscher-Ohlin theory excludes unemployment

This inquiry is related to vesture and production, therefore we assume that it refers to labor as its chief factor of production, therefore taking into consideration the construct of factor strength we can state that it is labour intensive, moreover unskilled labor intensifier. The bulk of exports and chief portion of production has been found to arise in that of the underdeveloped universe. The high labor intensity of the industry has meant there is really strong encouragement for companies to switch production to a lower labor cost country. These labour costs to a great extent weigh the pick in which location to industry ; strong fiscal inducements push production thoughts into relocating this labour intense production procedure to a low labor cost country. The production of these goods in a underdeveloped state would hold its competitory advantages for illustration cheaper natural stuffs and cheaper labor costs. From this we can construct upon the thought of cost minimization, the chief inducement for a state is to take down its costs and maximize its net incomes based on production determinations. In world, the factor equalization theorem does non keep, rewards are non equal between states. In the UK we have a minimal pay, and if we take a less developed state such as Vietnam this minimal pay is nonexistent and workers in the garment sector are paid every bit small as 49 cents.[ 4 ]

Companies such as Marks and Spencer are in concern to gain maximise through cost minimization, traveling to a less developed state for fabrication is cheaper for the company itself due to the state being labour intensifier and the goods produced demand this high labor strength. Under force per unit area to maintain monetary values low, most retail merchants look for cheaper beginnings of apparels than cut net income borders, hence relocate and establish their resettlement on quota allotment, bringing clip, substructure and most significantly labour costs. So an inducement to relocate to bring forth goods at a lower cost seems the cheaper, efficient and best move to do.