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3.

Heckscher-Ohlin Mode of Trade

Heckscher-Ohlin Model

1. Setup
2. Autarky Equilibrium
3. Free Trade Equilibrium
4. The Heckscher-Ohlin Theorem
5. The Factor-Price-Equalization Theorem
6. The Stolper-Samuelson Theorem
7. The Rybczynski Theorem

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Econ 3150 York U

3.Heckscher-Ohlin Mode of Trade

Problems with Ricardian model:
1. It predicts complete specialization
2. It predicts that all workers will gain from free trade. In real life
some workers oppose free trade. (E.g. U.S. steel workers oppose
free trade with China)

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Econ 3150 York U

3.Heckscher-Ohlin Mode of Trade

Heckscher-Ohlin Model:
 2 factors: capital (K) and labour (L) => concave production
frontier => no complete specialization, in equilibrium each
country produces both goods
 Comparative advantage is based on national differences in factor
endowments. Countries have different factors endowments (e.g.
capital, labour (skilled or unskilled), land etc.) Differences in
relative factor endowments result in differences in autarky
prices. E.g. countries that have relatively abundant supplies of
agricultural land (like Canada, USA) have cheaper autarky prices

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Econ 3150 York U

3.Heckscher-Ohlin Mode of Trade

of agricultural products and become exporters of agricultural
products.

The model predicts that trade leads to redistribution of income
between capital and labour => explains opposition to trade of
some factors of production

This model is favoured by economists and is supported by the
real world data. There is a great deal of evidence that differences
in factor endowments are important in explaining trade patterns.

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Econ 3150 York U

3. Setup 2 goods: X. capital gets rent r.Y 2 factors: K.L. labour gets wage w 2 countries: H. Identical CRS production functions in H and F 2. Kh. Lh.fixed factor endowments  factors are perfectly mobile within each country between X and Y sectors. Lf .Heckscher-Ohlin Mode of Trade 1. 5 Econ 3150 York U .F Assumptions 1. Kf.

H.) 6 Econ 3150 York U . F differ in relative factor endowments.) 4. (This will give rise to price differences in H and F.3. 3. No distortions (tariffs etc. homogenous preferences 5. Consumers in H. F have identical.Heckscher-Ohlin Mode of Trade  factors are immobile between countries.

then country H is relatively capital-abundant and labour-scarce. while country F is relatively labour-abundant and capital-scarce.Heckscher-Ohlin Mode of Trade Definition Factor Endowments If capital.labor ratio in country H is greater than it is in country F Kh K f  ( Lh L f ). 7 Econ 3150 York U .3.

3.421 120 3 40.Heckscher-Ohlin Mode of Trade Example K stock L ($b.S. 566 3. 8 Econ 3150 York U . but capital-scarce relative to Switzerland. is capital-abundant relative to Brazil.696 116 32.) (m) K L ($) Brazil US Switzerland 507 53 9.000 => U.

F is labour-abundant Eh Kh slope=home capital-labour ratio Ef Kf slope=foreign capital-labour ratio L Lh Lf 9 Econ 3150 York U . Factor Endowments Graph K H is capital-abundant.Heckscher-Ohlin Mode of Trade A.3.

Heckscher-Ohlin Mode of Trade Definition Factor Intensities Good Y is relatively capital-intensive and good X is relatively labour-intensive if the capital-labour ratio used in production of Ky Kx  good Y is higher: L y Lx 10 Econ 3150 York U .3.

804 514 11 Econ 3150 York U .263 Footwear 107 4.005 95 284.Heckscher-Ohlin Mode of Trade Example K $m L K L .3.$ thousands Petroleum 27.

For any price ratio. 12 Econ 3150 York U . Producers minimize costs => isoquant is tangent to w/r. at optimum ( K K ) y  ( )x L L => good Y is relatively capital-intensive.3.Heckscher-Ohlin Mode of Trade Take some price ratio w/r. X is relatively labour-intensive.

3. Factor Intensities Graph Y is capital-intensive. X is labour-intensive Ky Y slope=Y’s capital-labour intensity Kx X slope=X’s capital-labour intensity  w r L Ly Lx 13 Econ 3150 York U .Heckscher-Ohlin Mode of Trade K B.

F can produce (i.maximum amounts of goods X.Heckscher-Ohlin Mode of Trade Assume: 1. Y that H.3. X is L-intensive Yh . Country H is relatively K-abundant. country F is relatively Labundant 2. X f . if all resources are devoted to production of one good) 14 Econ 3150 York U .e. Y f . X h . Good Y is K-intensive.

Can be shown in 2 steps: 15 Econ 3150 York U .Heckscher-Ohlin Mode of Trade Result Yf Yh  Xh X f I.3. capital-abundant country can produce relatively more of capital-intensive commodity.e.

3. F are similar: K A. Factor Endowments Graph. F is labour-abundant Eh Kh Yf Kf Ef Xh Xf L Lh Lf 16 Econ 3150 York U . Isoquants for Y and X Yh H is capital-abundant. Assume that H.Heckscher-Ohlin Mode of Trade Step 1.

Home and Foreign PPFs Y Yh Home PPF Yf Foreign PPF X Xh Xf 17 Econ 3150 York U .3.Heckscher-Ohlin Mode of Trade Commodity Space.

Heckscher-Ohlin Mode of Trade Yh  Y f .3. L ). Xh X f Yf Yh  Xh X f are independent of sizes of the countries. X h  X f Step 2. Let X  f x ( K . A country grows and now has 3 times more capital and labour. CRS technology => => Yh Y f . L )  3 X 18 Econ 3150 York U . Y  f y (K . L ) be maximum amounts of goods X and Y that can be produced. The outputs of X and Y are: f x (3K .3L )  3 f x ( K .

Heckscher-Ohlin Mode of Trade f y (3K . the ratio stays the 3X X same: 3Y = Y . after growth.3. the ratio was Y . 19 Econ 3150 York U . L )  3Y X before growth.3L )  3 f y ( K .

Heckscher-Ohlin Mode of Trade Commodity Space.3. PPFs Y Yh Home PPF 2Y f Yf 1 Yh 3 Foreign PPF 1 Xh 3 Xf Xh 20 2X f X Econ 3150 York U .

Autarky Equilibrium Assume: H is capital-abundant country and Y is capital-intensive good.Heckscher-Ohlin Mode of Trade => Independently of country sizes. 2. PPF of a relatively capitalabundant country will be more stretched along the K-intensive axis.3. 21 Econ 3150 York U .

Heckscher-Ohlin Mode of Trade Autarky Y Yh Ah Home PPF Yf u ah Af P h u af P f Foreign PPF X Xh Xf 22 Econ 3150 York U .3.

Tangency between the PPF and indifference curve determines autarky price ratios: Pxh Px f  f h Py Py 23 Econ 3150 York U . Home and foreign production and consumption in autarky are at Ah and Af.3.Heckscher-Ohlin Mode of Trade Note: Identical homogenous preferences => H and F have parallel indifference curves.

F observe relatively cheaper Y abroad => H exports Y (k-intensive good) and imports X.Heckscher-Ohlin Mode of Trade => Capital-intensive good Y is relatively cheaper in capitalabundant country H. H observes relatively cheaper X abroad.3. 3. 24 Econ 3150 York U . Free Trade Equilibrium If countries open to trade. while labour-intensive good is cheaper in labour-abundant country F. F exports X (lintensive good) and imports Y.

and F produces less Y and more X Note: There is no complete specialization in this model. 25 Econ 3150 York U .Heckscher-Ohlin Mode of Trade H produces more Y and less X.3. both countries keep producing both goods after trade.

3.Heckscher-Ohlin Mode of Trade Move from Autarky to Free Trade Y Qh* Yh Ah Yf C h* u h* C *f u hA u *f Af Q u Af * f P* P* X Xf Xh 26 Econ 3150 York U .

4. The Heckscher-Ohlin Theorem Theorem The Heckscher-Ohlin Theorem A country will export the commodity that intensively uses its relatively abundant factor 27 Econ 3150 York U .Heckscher-Ohlin Mode of Trade  Trade equalizes prices in 2 countries  H. F produce both goods  Both H and F gain from trade.3.

3.Heckscher-Ohlin Mode of Trade Free Trade. Trade Triangles Y Qh* H’s exports of Y = C h* C u h* * f F’s imports of Y u *f P* Q *f P* X H’s imports of X 28 =F’s exports of X Econ 3150 York U .

The Factor-Price-Equalization Theorem After countries open to trade each country observes higher relative price for its exports: 29 Econ 3150 York U . This trade model predicts inter-industry trade. World price P* adjusts to keep trade balanced: H’s imports of X= F’s exports of X and H’s exports of Y= F’s imports of Y.Heckscher-Ohlin Mode of Trade Note: Empirically HO theorem applies better to countries with large differences in relative endowments (e. 5. USA – Mexico trade).3.g.

exports X (l-intensive good).Heckscher-Ohlin Mode of Trade H: observes higher relative price for Y.  demand for labour =>  r and  w =>  w/r F: observes higher relative price for X. resources are reallocated from sector X to sector Y =>  demand for capital.  demand for capital =>  w and  r =>  w/r 30 Econ 3150 York U . exports Y (k-intensive good).3. resources are reallocated from sector Y to sector X =>  demand for labour.

2.e. 1. r Py such that  Px Py =>  w r .Trade: Ph=Pf =P* => w w ( )h  ( ) f r r 31 Econ 3150 York U .F.) is identical in H.Heckscher-Ohlin Mode of Trade  there is a relationship between prices of goods and factor prices: P w  G( x ) . labour is relatively cheaper in labour-abundant country. F is identical =>function G(. capital is relatively cheaper in capital-abundant country.3.In autarky: Ph>Pf => w w ( )h  ( ) f r r i. Note: technology in H.

3. 32 Econ 3150 York U .Heckscher-Ohlin Mode of Trade Theorem The Factor-Price Equalization Theorem Under identical CRS production technologies free trade in commodities will equalize relative factor prices through equalization of relative commodity prices so long as both countries produce both goods.

3.r (The StolperSamuelson Theorem)  Change in endowments Δ K . L => change in outputs of X.Heckscher-Ohlin Mode of Trade 2 fundamental relationships:  Change in price ΔP (e.g. change from autarky price Pa to free trade price P*) => change in factor rewards w.Y (The Rybczynski Theorem) 33 Econ 3150 York U .

3.Heckscher-Ohlin Mode of Trade 6. The Stolper-Samuelson Theorem Theorem The Stolper-Samuelson Theorem If there are constant returns to scale and if both goods continue to be produced. 34 Econ 3150 York U . a relative increase in the price of a commodity will increase the real return to the factor used intensively in that industry and reduce the real return to the other factor.

.3. while real returns to capital owners will fall. If Px/Py increases. real returns to workers will increase.Heckscher-Ohlin Mode of Trade Assume X is a labour-intensive good. Real wages: Px Py Px Py 35 Econ 3150 York U . . Proof: w w r r .

3.Heckscher-Ohlin Mode of Trade SS:  Px Py  w w . Px Py Note: in equilibrium. factor price=value of marginal product Recall labour market equilibrium conditions: Sector X: Sector Y: w  Px MPLx w  Py MPL y r  Px MPK x r  Py MPK y 36 Econ 3150 York U . Px Py =>  r r .

3. so that  Px Py Px Py affects marginal =>  MPL in both sectors.Heckscher-Ohlin Mode of Trade Real wages: w  MPLx Px w  MPLy Py r r  MPK y  MPK x . Py Px We have to show that change in relative prices products in X and Y sectors. and  MPK in both sectors. 37 Econ 3150 York U .

 Px Py =>  output of X => demand for labour increases relative to demand for capital because X is a labour-intensive good =>  w/r – labour becomes relatively more expensive =>  K/L ratio both in production of X and Y (producers substitute away from relatively more expensive input). 38 Econ 3150 York U .Heckscher-Ohlin Mode of Trade 2 steps (no rigorous proof required) Step 1.3.

Factor Intensities Graph: change in w/r Y is capital-intensive. X is labour-intensive  w ’ r Ky Y Kx slope=Y’s capital-labour intensity X slope=X’s capital-labour intensity  w r L Ly Lx 39 Econ 3150 York U .3.Heckscher-Ohlin Mode of Trade K  w ’ r B.

 MPK (because of law of diminishing returns) Recall Properties of Production Function: 40 Econ 3150 York U .Heckscher-Ohlin Mode of Trade (note: homothetic production function: same K/L ratio for all levels of Y (or X) for any w/r) Step 2.3.  K/L =>  MPL.

41 Econ 3150 York U . If use of L in the production of X is increasing. total product of labour is increasing at a decreasing rate.Heckscher-Ohlin Mode of Trade  Law of Diminishing Marginal Product.3.

K 2 ) .slope of TP curve L1 L2 42 Lx Econ 3150 York U . K 2 ) X C B TPx ( Lx . K1 ) .Heckscher-Ohlin Mode of Trade Law of Diminishing Marginal Product: Total Product Diagram TPx ( Lx .3. K1 ) A L1 L2 Lx Marginal Product Diagram X C B A  MPLx ( Lx .slope of TP curve MPLx ( Lx .

Keep labour fixed at L1. K MPK  f ( ) : L  K L  K L  MPL  43 .Heckscher-Ohlin Mode of Trade 1. (Movement from A to C on Total Product or Marginal Product graph). MPL  f ( Similarly. Increase labour from L1 to L2 keeping capital fixed at K1 .  MPK x .3.  TPL increases. 2. K L   K L MPL  MPK Econ 3150 York U . increase K2 . MPL falls. (Movement from A to B on Total Product or Marginal Product graph).  TPL increases. K ) L : Generally. MPL increases.

44 Econ 3150 York U . if K  by 15%. and L  by 10%  MPL  because capitallabour ratio goes up. but MPK falls.g.3.Heckscher-Ohlin Mode of Trade E.

As a result of trade. A H: P*<Pf =>  Px Py =>  w/r. capital-owners lose. labour-abundant country F (relatively cheap X) enters free trade with capital abundant country H (relatively cheap Y). within each country prices change to the world price P*. A F: P*>Ph =>  Px Py =>  w/r .g.Heckscher-Ohlin Mode of Trade Application of Stolper-Samuelson Theorem: E. workers gain from trade in real terms. 45 Econ 3150 York U . workers lose. capital-owners gain.3.

46 Econ 3150 York U . unskilled labour is relatively scarce in the U.e.Heckscher-Ohlin Mode of Trade Country exports services of the relatively-abundant factor => increase demand for abundant factor => higher return to abundant factor. Relatively abundant factor gains from trade. while scarce factor loses.g. => workers protest free trade with developing countries and demand protection. (I.) E. relatively scarce factor loses from trade. but the gain is incurred by the abundant factor only. Trade in HO model has redistributional effect: there is aggregate gain from trade. abundant factor gains more that average. while the scarce factor incurs loses.S.3.

Heckscher-Ohlin Mode of Trade 7. an increase in a supply of a factor will lead to an increase in output of the commodity using that factor intensively. and a decrease in the output of the other commodity 47 Econ 3150 York U .3. The Rybczynski Theorem Theorem The Rybczynski Theorem If relative commodity prices are constant and if both commodities continue to be produced.

output of Y will decrease. it will produce more of good Y and less of good X. immigration => increase in L . NO! Output of X will increase.one may expect that outputs of X and Y will both increase.3.g. Y Growth in Labour Endowment (X is labour-intensive good) Y Output expansion P X P X X 48 Econ 3150 York U .Heckscher-Ohlin Mode of Trade E. If home country increases its capital stock.

49 Econ 3150 York U . Countries with low saving rates but high population growth would tend to produce goods and export goods with high labour contents. The way in which country growth has an impact on its production and trade mixes.Heckscher-Ohlin Mode of Trade The theorem is important as it predicts the impact of economic growth on trade.3. Countries with high saving and investment rates will produce and export more capitalintensive goods.