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Modern Theory Of International Trade | Price line | Community Indifference Curve

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This theory is also known as factor endowment theory presented by heckschre and ahlin (H.o) two economists) According to this theory; ALLAH has gifted different resource to different countries.

This theory is also known as factor endowment theory presented by heckschre and ahlin (H.o) two economists) According to this theory;

ALLAH has gifted different resource to different countries .i.e some countries are rich in labor. Some in land and some in capital etc so due to difference in resources every country has comparative advantages in its line of production.

Thus according to this theory;

The country which is rich in labor will produce those goods in which more labors are required and will export labor incentive goods,while the country which is rich in capital will produce those goods in which are capital in required and will export capital incentive goods. Accordingly Pakistan being rich in labor will export cloth and U.S.which is rich in capital will export capital incentive goods like air-crafts,computer etc.

To explain this theory first we will explain come tools required for the explanation of the theory.

PPC (Production Possibility Curve):

PPc is that curve which shows different combination of two goods wheat and cloth which the economy can produce using all of its resources of capital and labor.

The ppc (aac) curve wheat is concave downward, A which shows that if the economy. produces more of cloth,it will have to decrease the production of wheat.where MRTS is sing or it is getting less of cloth by forgiving the some of wheat the resources withdrawn from wheat are not best suited for the production of cloth.

Price line:

The price line explains the relationship between

The price line explains the relationship between W and c i.e how much of cloth will be exchanged for how much of wheat and wheat is the price ration between C and W.

Community Indifference Curve :

A Community indifference curve shows pairs of two goods i.e w and c which give equal level of satisfaction to the whole community Higher C/C gives higher level of satisfaction.

Consumption and Production Of A Country In Autoworker:

The economy will be in equilibrium where a ppc is tangent to cic and price line as shows in equilibrium takes place where ppc (AA) is tangent to price line popo and economy produces oc of cloth and ow of wheat (pre-trade situation).

When Trade Starts?

According To heckscher-ohlim Modle:

A country which is rich in labor will produce and export labor intensive goods.and a country which is rich in capital will produce and export capital intensive goods and will import labor intensive goods.

Assuming Two Nation Pakistan and U.S:

Cloth is capital intensive goods, so u.s will produce and export cloth,while import wheat. Contrary wheat is labor intensive good,so Pakistan will produce and export wheat while import cloth. Before trade basic equilibrium of production and consumption takes place at point E where C1C2 is tangent to ppc and price line i.e c1c2=po=AA after trade U.S will not fully specialize in production of cloth,but at F where international price line ratio p1p1 is tangent to ppc.

So U.S produce cpu of cloth and WPU of wheat now u.s produces cpu of cloth ans wpu of wheat. now U.S consumes at E2 where c1c2 touches the p1p1.

Hence it consumes ccu of cloth and wcu of wheat thus it represents that u.s exports cloth equal to ocpu-occu and imports wheat equal to owcu-owpu.thus u.s exports BF which is capital-intensive and imports(labor intensive) wheat which BE2. basic equilibrium takes place at G (per-trade situation)where c1c2 is tangent to ppc and price line.

After trade pak specializes (not fully) in the wheat production by producing at K where p1p2 is tangent to ppc. Accordingly it produces wpp of wheat and ccp of cloth. Pakistan consumes at R where ic2 touches p1p1.hence it consumes wcp of wheat and ccp of cloth.

Thus it is clear that Pakistan exports wheat equal to occp-ocpp. thus Pakistan export MK of wheat of cloth which is (capital intensive).

Assumption

  1. It is 2x2 model (two countries trade b/w 2-goods)
  2. there is free trade between two countries.
  3. labor is mobile domestically, but immobile internationally.
  4. there is perfect competition in goods and factors market.
  5. there is no transportation costs.
  6. constant returns to scale is applied in both countries.


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