There are several models that are used to analyze the dynamics of international trade.
Two such models are Ricardian and Heckscher-Ohlin models. Let’s look at each of them in detail.
Ricardian Model
- The focus is on comparative advantage. The model suggests that the countries specialize in producing goods and services that they can do best.
- The model assumes that there is only one factor of production, that is, labor.
- The model suggests that the trade occurs between countries because of the differences in labor productivity that occurs because of technological differences.
- The model applies in the short-run because the technology can change internationally over time.
Heckscher-Ohlin Model
- Unlike Ricardian Model, the model suggested by Heckscher-Ohlin assumes that there are two factors of production, namely, labor and capital.
- One country has comparative advantage over the other because of the differences in relative amounts of each factor.
- The model suggests that countries should produce and export goods using the resources that they have in abundance. Similarly, the countries should import goods that require resources that they have in short supply.
- Note that this model differs from the comparative advantage theory that focuses on the efficiency of the production process. Because the country produces goods based on the resources that they have in abundance, it will be cheapest to produce these goods. Very broadly, countries that have more capital will specialize in capital-intensive goods and countries that countries with more labor will specialize in labor-intensive goods. These countries will trade these goods with each other.
- This model assumes that labor and capital can flow freely between sectors and that the amount of these two factors differs among countries.
- The model also assumes that in the long-run countries have same technology.
The Heckscher-Ohlin model suggests that there will be a redistribution of wealth between the labor and owners of capital.
The price of the resource that’s abundant in each country will increase. This is because the goods that a country exports will rise in price and the goods that a country imports will fall in price. For example, for a capital-intensive industry, when they start exporting the goods, the demand for capital will rise, and the owners of capital will receive more income at the cost of labor in that country. Similarly, for a labor-intensive country, increase in production of the labor-intensive good increases the demand for labor and the workers receive more income at the cost of the capital owners.