The HeckscherOhlin Theory

1
The Heckscher-Ohlin Theory

• Chapter 4

2
Problems with Classical Model

• It has some of the strict assumptions
• The assumption of constant opportunity costs
• The notion that trade arose due to the
  differences in productivity level between
  countries
• It also offers some of the extreme predictions
  that are not borne out in real world trade pattern

3
Heckscher-Ohlin Model

• Based on two different characteristics of
  countries and products
• Countries differ from each other according to the
  factors of production they possess
• Goods differ from each other according to the
  factors that are required in their production
• H-O model argued that a country will be able to
  produce at lower cost those products whose
  production requires large amounts of factors of
  production with which the country is relatively
  well endowed

4
Assumptions

• Keep all the seven assumptions we discussed in
  developing model for autarky model and first
  three assumptions for trade model
• We drop 2 assumptions1) labor is the only
  relevant factor of production and 2) technology
  can be described only with unit of labor inputs
• In addition, HO model has five more assumptions.

5
HO Model

• We add five new assumptions
• (Assumption 13) There are two factors of
  production labor (L) and capital (K). Also,
  owners of capital are paid a rental payment (R)
  for the services of their assets. Labor receives
  a wage payment (W).
• This assumption relaxes one of the strict
  assumptions of the classical model, i.e., labor
  was the only relevant factor of production and
  used in the same proportion along with machines
  in the production process.

6
Assumptions

• (Assumption 14) The technology sets available to
  each country are identical.
• One of the crucial assumptions in HO model. It
  implies that for production of any good,
  producers in both countries have ready access to
  the same choices of production techniques.

7
Assumptions

• (Assumption 15) In both countries, the production
  of T always requires more labor per machine than
  the production of S. The production of both
  goods in both countries is subject to constant
  return to scale.
• The first part of this assumption says that T is
  more labor intensive than S or S is more capital
  intensive than T.
• LT/KT gt LS/KS or KT/LT lt KS/LS

8
Assumptions

• The second part of the assumption says that
  proportionate changes in the use of capital and
  labor lead to equiproportionate changes in the
  output.
• To double the output of textiles would require
  doubling of the amount of labor and capital
  employed in the textile industry.

9
Assumptions

• (Assumption 16) Countries differ in their
  endowments of factors of production, L and K. In
  this case, we assume that A is relatively capital
  abundant while B is relatively labor abundant.

10
Assumptions

• Combining the implications of the last two
  assumptions allows us to develop graphically the
  shapes of the production possibility frontiers
  for both countries
• The PPF of each country will show increasing
  opportunity costs

11
Assumptions

• The last assumption refers to the demand
• (Assumption 17) Tastes in the two countries are
  identical
• This states that community indifference curve in
  both the countries are identical
• It implies that given the same prices and income,
  both countries would consume exactly the same
  amounts of two goods

12
The HO Theorem

• It states that a country will have comparative
  advantage in, and therefore will export, that
  good whose production is relatively intense in
  the factor with which that county is relatively
  well endowed
• For example A capital abundant country will
  export in the good that requires more capital per
  worker to produce

13
Graphical Representation of The HO Theorem
14
The Effects of Rising Prices of good S on Country
As Trade
15
Trade Equilibrium in the HO Model
16
Some Features of HO Model

• Incomplete specialization in production as
  compared to complete specialization in Classical
  model.
• The manner in which the process of reciprocal
  demand leads to an equilibrium terms of trade.

17
Reciprocal Demand in the Classical and HO Model