Using the concepts of community indifference curves and the production-possibility curve, explain how the international price of a good is determined in the Heckscher-Ohlin two-commodity model. What is the unit of measurement for the price of a good in this model?
What will be an ideal response?
POSSIBLE RESPONSE: The production-possibility curve (PPC) illustrates the maximal quantities of two goods that a country can produce with full employment of its resources. The combination of quantities that the producers will eventually decide to produce along the PPC will depend on the relative price of the good (expressed in terms of the other good to be given up). A community indifference curve indicates all combinations of quantities of the two goods, which provide the same well-being to the community. The PPC can be used to derive the marginal cost of a product (expressed in terms of the other good to be given up), which in turn, defines the supply of this product. Community indifference curves can be used to derive the demand for the product. The international price of a good in the Heckscher-Ohlin model is determined in such a way, that the excess domestic supply in one of the countries is matched by the shortage (excess domestic demand) in the other country. The first country exports the good in exchange for importing the other good.
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