Consider a Heckscher-Ohlin model of US trade with East Asian newly industrializing countries (China, Korea, Taiwan, etc., which we’ll call "EA"). Suppose that the two factors of production are capital (K) and labor (L). The price of capital is denoted by r and the wages of labor are w. The U.S. is capital-abundant. There are two goods, X (electronic gadgets) and Y (heavy machinery), and good X is labor-intensive.
a. Give precise definitions of what it means for the U.S. to be capital-abundant and for good X to be labor-intensive in this model. Can you tell from this information which "country" (US or EA) has absolutely more capital? More workers? Why or why not?
b. Draw the production possibility frontiers (PPFs) and demand curves for the two countries, showing the autarky [no trade] equilibria (consumption and production points) as well the autarky relative prices and the free trade relative prices, production, and consumption points. Show which country has a comparative advantage in each good and explain.
c. Analyze the predicted effects of free trade on income distribution in the US and EA using the Stolper-Samuelson theorem. Which factor owners are predicted to gain or lose in each country? Why? Should trade liberalization between the US and EA lead to more or less inequality, in the US and EA, according to this model? Discuss and draw diagrams showing predicted changes in factor prices. (You may assume that capital owners are richer than workers to begin with.)
d. Suppose there is no free trade, but labor can migrate freely from one country to another. Which way would workers migrate? Why? What if capital were mobile—which country would capital move out of and which country would it be invested in? Why? How would the distributional effects of such factor mobility compare with the effects of trade discussed in part c.?