International Economics: Heckscher-Ohlin Theory

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CHAPTER F I V E
5 International Economics
Tenth Edition
Factor Endowments and the

Heckscher-Ohlin Theory
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Heckscher-Ohlin Theory
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Learning Goals:
 Explain how comparative advantage is based on

differences in factor endowments across nations
 Explain how trade affects relative factor prices
within and across nations
 Explain why trade is likely to be only a small
reason for higher skilled-unskilled wage
inequalities
In this chapter:
 Introduction
 Assumptions of the Theory
 Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier
 Factor Endowments and the Heckscher-Ohlin
Theory
 Factor-Price Equalization and Income
Distribution
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Introduction
 Extending trade model to include:

 Basis of comparative advantage
 Effect of international trade on return to labor
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Factor Endowments: Which case has
higher amount of capital per unit of labor?
Case 1 Case 2
Capital (K)
Capital (K)
Labour (L)
Labour (L)
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Factor Intensity, Factor Abundance, and the

 Factor Intensity
 In a two-commodity, two factor world,
commodity Y is capital intensive if:
 Note:
K/L: the amount of capital per unit of labor
(K/L) Y > (K/L) X

 Factor Intensity
 In a two-commodity, two factor world,
commodity Y is capital intensive if the capital-
labor ratio (K/L) used in the production of Y is
greater than K/L used in the production of X.
 It is not the absolute amount of capital and labor

used in production of X and Y, but the amount of
capital per unit of labor that determines capital
intensity.
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Factor intensity
Bottled water
clothing
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FIGURE 5-1 Factor Intensities for Commodities X and Y

in Nations 1 and 2.
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 Factor Abundance
 In terms of physical units: Nation 1 is labor
abundant & Nation 2 is capital abundant if:
 In terms of relative factor prices: Nation 1 is

labor abundant & Nation 2 is capital abundant if:
OR
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Case Study 5-2 Capital-Labor Ratios of

Selected Countries
Homework: Replicate the above table using the most updated data.
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 In terms of physical units: China is labor
abundant & USA is capital abundant if:
 In terms of relative factor prices: Nation 1 is

labor abundant & Nation 2 is capital abundant if:
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 In terms of physical units:
 Nation 2 is capital abundant if the ratio of the
total amount of capital to the total amount of
labor (TK/TL) available in Nation 2 is greater
than that in Nation 1.
 It is NOT the absolute amount of capital and

labor available in each nation, but the ratio of
the total amount of capital to the total amount
of labor.
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 In terms of relative factor prices:
 Nation 2 is capital abundant if the ratio of the
rental price of capital to the price of labor time
(PK/PL) is lower in Nation 2 than in Nation 1.
 Rental price of capital is usually considered to

be the interest rate (r), while the price of labor
time is the wage rate (w), so PK/PL = r/w.
 It is NOT the absolute level of r that determines
whether a nation is K-abundant, but r/w.
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Heckscher-Ohlin (H-O) theory is based on

two theorems
The factor price

equalization
The H-O theorem
theorem (which
(which deals with
deals with the
and predicts the
effect of
pattern of trade)
international trade
on factor prices).
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1. The H-O theorem

A nation will export
the commodity the commodity

whose production whose production
requires the requires the
intensive use of intensive use of
the nation’s the nation’s
and import
relatively relatively scarce

abundant and and expensive
cheap factor factor.
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1. The H-O theorem
In short, the relatively

labor-rich [labor-
abundant] nation
exports the relatively
labor-intensive
commodity and imports
the relatively capital-
intensive commodity
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Factor Endowments and the Heckscher-Ohlin

Theory
 Heckscher-Ohlin (H-O) theory is based on

two theorems:
1. The H-O theorem
 In short, the relatively labor-rich nation exports
the relatively labor-intensive commodity and
imports the relatively
 Explains comparative advantage rather than
assuming it.
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What is the
basic cause
[determinant]
of comparative
advantage?
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FIGURE 5-3 General Equilibrium Framework of the

Heckscher-Ohlin Theory.
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 Figure 5.3 shows clearly how all economic forces

jointly determine the price of final commodities.
 This is what is meant when we say that the H–O
model is a general equilibrium model.
 However, out of all these forces working together,
the H–O theorem isolates the difference in the
physical availability or supply of factors of
production among nations (in the face of equal
tastes and technology) to explain the difference in
relative commodity prices and trade among
nations.
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Factor-endowment theory
U.S. U.K.
Wheat (bushels/hour) 6 1
Cloth (yards/hour) 4 2
Opportunity cost U.S. U.K.
(Autarky)
Wheat 1W = 2/3C 1W = 2C
⇨ W/C = 2/3 W/C = 2
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 In which nation, the relative price of wheat is lower?

 Which nation has a comparative advantage over the
other nation in wheat? Which in cloth?
 What is the basic cause [determinant] of the nation’s
comparative advantage if
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Difference in
relative factor
Pretrade
abundance Basic cause
difference in
[factor [determinant]
relative
endowments] or of comparative
commodity
factor prices advantage
prices
between two
nations
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 Of all the possible reasons for differences in
relative commodity prices and comparative
advantage among nations, the H–O theorem
isolates the difference in relative factor
abundance, or factor endowments, among
nations as the basic cause or determinant of
comparative advantage and international
trade
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FIGURE 5.2. The Shape of the Production Frontiers

of Nation 1 and Nation 2.
1/ Which
Nation can
produce
relatively
more of
commodity
X?
2/ What is
the reason
for this?
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Case Study 5-1 Relative Resource

Endowments of Various Countries
Homework: Replicate the above table using the most updated data.
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2. The factor price equalization

theorem
In short, wages (return

to homogeneous labor)
and other factor
returns (ex. return to
homogeneous capital)
will be the same after
specialization and
trade has occurred.
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homogeneous labor: labor with the same

level of training, skills, and productivity
homogeneous capital: capital of the same

productivity and risk
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2. The factor price equalization theorem
 International trade will bring about equalization in

the relative and absolute returns to homogenous
factors across nations.
 As such, international trade is a substitute for
the international mobility of factors.
 Holds only if H-O theorem holds.
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theorem
 Will the wage rate w in USA fall or rise if it

specializes in the production of commodity W (the L-
intensive commodity) and reduces its production of
commodity C?
 What is the reason for this?
 How about the interest rate r?
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 From Section 5.4, we know that in the absence of

trade the relative price of commodity X
is lower in Nation 1 than in Nation 2 because the
relative price of labor, or the wage rate, is
lower in Nation 1.
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 As Nation 1 specializes in the production of

commodity X (the L-intensive commodity) and
reduces its production of commodity Y (the K-
intensive commodity), the relative demand for
labor rises, causing wages (w) to ____(rise or fall?),
while the relative demand for capital falls, causing
the interest rate (r) to ____(rise or fall?).
 The exact opposite occurs in Nation 2. That
is, as Nation 2 specializes in the production of Y
and reduces its production of X with trade,
its demand for L falls, causing w to fall, while its
demand for K rises, causing r to rise
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 International trade causes w to rise in Nation 1

(the low-wage nation) and fall in Nation 2. (the
high-wage nation), reducing the pretrade
difference in w between nations.
 Similarly, trade causes r to fall in Nation 1 (the K-
expensive nation) and rise in Nation 2. (the K-
cheap nation), reducing the pretrade difference in
r between nations.
 Thus, international trade causes a redistribution
of income from the relatively expensive (scarce)
factor to the relatively cheap (abundant) factor.
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theorem
International trade not

only tends to reduce the
international difference
in the returns to
homogeneous factors,
but would in fact bring
about complete
equalization in relative
factor prices.
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theorem
International trade
is a substitute for the international
mobility of factors.
causes a redistribution of income

from the relatively expensive
(scarce) factor to the relatively
cheap (abundant) factor.
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Assumptions of the Theory
 Heckscher-Ohlin theory based on following

assumptions:
1. Two nations, two goods, two factors of
production
2. Technology is the same in both nations
3. Commodity X is labor intensive, commodity Y is
capital intensive in both nations
4. Constant returns to scale for X and Y in both
nations
5. Incomplete specialization in production in both
nations
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Assumptions of the Theory
 Heckscher-Ohlin theory based on following

assumptions (continued):
6. Tastes are the same in both nations
7. Both commodities and factors are traded in perfectly
competitive markets
8. Perfect factor mobility within each nation, but not
between nations
9. No transportation costs, tariffs or other barriers to
free trade.
10. All resources are fully employed in both nations
11. International trade between the nations is balanced.
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FIGURE 5-5 Relative Factor–Price Equalization.

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Factor-Price Equalization and Income

Distribution
 Specific Factors Model

 Trade will:
 benefit the immobile factors specific to a
nation’s export commodities or sectors, and
 harm the immobile factors specific to a nation’s
import-competing commodities or sectors.
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Case Study 5-7 Capital and Labor Requirements

in U.S. Trade
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International Economics: Heckscher-Ohlin Theory

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05/12/2020

Factor Endowments and the

 Explain how comparative advantage is based on

 Extending trade model to include:

Factor Intensity, Factor Abundance, and the

(K/L) Y > (K/L) X

Factor Intensity, Factor Abundance, and the

 It is not the absolute amount of capital and labor

FIGURE 5-1 Factor Intensities for Commodities X and Y

Factor Intensity, Factor Abundance, and the

 In terms of relative factor prices: Nation 1 is

Case Study 5-2 Capital-Labor Ratios of

Factor Intensity, Factor Abundance, and the

 In terms of relative factor prices: Nation 1 is

Factor Intensity, Factor Abundance, and the

 It is NOT the absolute amount of capital and

Factor Intensity, Factor Abundance, and the

 Rental price of capital is usually considered to

Heckscher-Ohlin (H-O) theory is based on

The factor price

1. The H-O theorem

the commodity the commodity

relatively relatively scarce

1. The H-O theorem

In short, the relatively

Factor Endowments and the Heckscher-Ohlin

 Heckscher-Ohlin (H-O) theory is based on

FIGURE 5-3 General Equilibrium Framework of the

 Figure 5.3 shows clearly how all economic forces

⇨ W/C = 2/3 W/C = 2

 In which nation, the relative price of wheat is lower?

FIGURE 5.2. The Shape of the Production Frontiers

Case Study 5-1 Relative Resource

2. The factor price equalization

In short, wages (return

homogeneous labor: labor with the same

homogeneous capital: capital of the same

2. The factor price equalization theorem

 International trade will bring about equalization in

2. The factor price equalization

 Will the wage rate w in USA fall or rise if it

2. The factor price equalization theorem

 From Section 5.4, we know that in the absence of

2. The factor price equalization theorem

 As Nation 1 specializes in the production of

2. The factor price equalization theorem

 International trade causes w to rise in Nation 1

2. The factor price equalization

International trade not

2. The factor price equalization

causes a redistribution of income

Assumptions of the Theory

 Heckscher-Ohlin theory based on following

Assumptions of the Theory

 Heckscher-Ohlin theory based on following

FIGURE 5-5 Relative Factor–Price Equalization.

Factor-Price Equalization and Income

 Specific Factors Model

Case Study 5-7 Capital and Labor Requirements

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