Assume a two-country, two-product model where the countries are A and B and the products are Y and Z. In the free trade equilibrium, the international price of good Z is less than the no trade price of good Z would be in Country A. Explain why, for Country A, Ricardo's comparative advantage model predicts full specialization, while the Heckscher-Ohlin model predicts only partial specialization in the production of two goods.

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE: When trade becomes possible, the international price of a good Z initially is lower than the opportunity cost of producing it in Country A. This implies that, starting from no trade, it is cheaper to buy good Z in the international market in exchange for the other good, good Y. The production of good Z decreases, and resources in Country A can instead be more efficiently employed in the production of good Y. How far does this shift of resources go?

Ricardo considered only labor as a production resource and assumed that production has constant costs. This implies that to double production, the producer just needs to employ twice as much labor. The opportunity cost in Ricardo's model is constant, which implies that the production possibilities curve is a straight line. Since the marginal cost remains unchanged, irrespective of the quantities of both goods being produced, Country A can completely specialize in the production of good Y and exchange it for good X in the international market. In contrast, the Heckscher-Ohlin model has (at least) two factors of production, and this implies that the opportunity cost of producing a good increases with an increase in its output. So, there can be a certain quantity combination of the two goods along the PPC, where the opportunity cost will match the international price. This is the optimal quantity combination of production for Country A, and only partial specialization takes place.