The Heckscher-Ohlin Model Purpose: The main goal of this assignment is to show how differences in resources generate a specific pattern of trade and discuss why the gains from trade will not be equally spread even in the long run and identify the likely winners and losers. Another goal is to illustrate the possible links between increased trade and rising wage inequality in the developed world and discuss other potential explanations for increasing inequality. Question 1 The United States is abundantly endowed with highly skilled labor while low-skilled labor is correspondingly scarce. Mexico on the other hand, is abundant in unskilled workers compared to the United states. Suppose Software is a highly skilled labor-intensive industry relative to the textile industry. Pt' a. Draw the production possibility frontier for each country (computer software on the x-axis) and determine the production choice of each country given a relative price of "software" Recall that each economy produces at the point that maximizes the value of production given the prices it faces. b. Use your answer to part (a) to draw the relative supply curve for the U.S. and for Mexico along with the world relative supply and demand curves on the y-axis and 2 on the x- axis). c. On the graph, show where would be U.S. and Mexico's equilibrium outcomes in the absence of trade, and explain how trade would affect the equilibrium relative price for each country. (ie. would the U.S. experience an increase (or decrease) in the relative price of software? What about Mexico) d. Use the Stolper-Samuelson theorem to illustrate graphically how the opening of trade affects the skilled-unskilled labor ratio used in the production of both goods in each country. (See Figure 5.7) e. How would the opening of trade affect production of software/textile in each country? Which country would export software? Textile? Are these result consistent with the Heckscher-Ohlin theorem? f. How would the opening of trade affect the income distribution in each country? EXPLAIN! g. Does the prediction of the model regarding the real wages of skilled and unskilled workers in Mexico consistent with the data? h. Does the prediction of the model regarding the skilled-unskilled labor ratio (part -d) used in the production of both goods in the U.S. consistent with the data? i. Identify two factors that were discussed in class and in the textbook which focus on the demand for labor, and show how these factors can explain both the income distribution pattern in Mexico (wages of skilled/unskilled workers) and the changes in the skilled- unskilled labor ratio in the U.S. j. Discuss three explanations for why the prediction of the Heckscher-Ohlin model that factor prices will be equalized among countries that trade is not consistent with the data.