Page 64 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes (iii) The term "gains from trade" describes:
Producer surplus.
(a) The fact that when two countries trade, both are better off.
(b) Profits made by businessmen involved in international trade.
(c) The income of middlemen in a transaction.
(d) Consumer surplus.
(iv) Why do some people argue against free international trade?
(a) Trade alters the distribution of income between broad groups of people.
(b) There is disagreement on whether or not there are gains from trade.
(c) Free trade threatens our country's security.
(d) The U.S. is a large country and therefore does not gain from international trade.
(v) Which of the following theories was proposed by David Ricardo?
(a) Theory of differences in factor endowments.
(b) Theory of differences in labor productivity.
(c) Theory of random components determining the pattern of trade.
(d) Theory of differences in climate and resources.
(vi) What are most trade policies driven by?
(a) Conflicts of interest within nations.
(b) Conflicts of interest between nations.
(c) Disagreements on the prices of major commodities.
(d) Disagreements regarding who should produce certain products.
4.4 Summary

• Heckscher (1919) stated that free trade equalizes factor rewards completely. Ohlin (1933), on
the other hand argued that full factor-price equalization cannot occur in practice. Ohlin asserted
that free trade brings about only a tendency towards factor-price equalization, and only a partial
factor-price equalization is possible. The later models by Stolper and Samuelson (1941) and
Uzawa (1959) also support partial equalization thesis. The later works of Samuelson (1948,
1949, 1953) and of Lerner (1953) make out a case for complete factor-price equalization.
• In order to demonstrate how the fector-price equalization takes place as a result of international
trade, we will use our model of two countries (country A and B), two commodities (goods X
and Y) and two factors of production (capital K, and Labour, L). Before trade (i.e. in a situation
of autarky) we have the following situations : (1) In country A, a labour surplus country, labour
is abundant and cheap and capital is scarce and expensive. Therefore, the K/L (or capital labour
ratio) is rather low. And once the trade is opened up, labour becomes relatively scarce and the
price of labour will go up. Similarly, capital becomes relatively abundant and hence the cost of
capital will go down.
• Recent contributions to the pure theory of international trade have relied heavily on the factor
proportions analysis developed by the two Swedish economists, Eli Heckscher (1919) and Bertil
Ohlin (1933). According to their theory, the immediate cause of international trade is, the
differences in the relative prices of commodities between the countries, and these differences in
the commodity prices arise on account of the differences in the factor supplies in the two countries.
• In the Heckscher-Ohlin model, the two countries are distinguished by the differences in factor
endowments or ‘factor abundance’ i.e. one country is capital abundant (or capital rich) and the

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