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Chapter 5 - International Economics

International Economics (‫)ةرهاقلا ةعماج‬

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CHAPTER F I V E

5 International
Economics
Tenth Edition

Factor Endowments and the

Heckscher-Ohlin Theory
Dominick Salvatore

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Learning Goals:
After reading this chapter, you should be able to:
Extend trade model to include:
Basis of comparative advantage
Effect of international trade on return to labor
labo
Explain how comparative advantage is based on
differences in factor endowments across nations.
Explain how trade affects relative factor prices
WITHIN and ACROSS nations.

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Assumptions of the Heckscher-Ohlin Theory

H-O theory is based on following assumptions:

1- Two nations, two goods, two factors of production.
2- Both nations use same technology in production.
3 C
3- dit X is
Commodity i labor
lab intensive,
i t i dit Y is
commodity i
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 Heckscher-Ohlin Theory

6- Tastes are the same in both nations.

7- Both commodities and factors are traded in
perfectly competitive markets.
8- Perfect factor mobilityy 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 nations is balanced.

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Factor Intensity, Factor Abundance, and the

Shape of the PPF

DEFINITION
Factor Intensity:
Commodity Y is capital intensive if capital-
labor ratio (K/L) used in production of Y is
greater than (K/L) used in production of X.

It is not the absolute amount of capital and

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

in Nations 1 and 2.

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Factor Intensity, Factor Abundance, and the

Shape of the PPF

Factor Abundance: (In terms of physical quantities):

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
total amount of capital to total amount of
labor.

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Factor Intensity, Factor Abundance, and the

Shape of the PPF

Factor Abundance: (In terms of relative factor prices):

Nation 2 is capital abundant if the ratio of the
price of capital to the price of labor (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.
0)

It is not the absolute level of (r) or (w) that

determines whether a nation is K-abundant, but
the ratio r/w.
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FIGURE 5-2 The Shape of the Production Frontiers of

Nation 1 and Nation 2.

Nation 2 is K-abundant, and

commodity Y is K-intensive

Nation 1 is L-abundant, and

commodity X is L-intensive

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The (H-O) theory is based on two theorems:

1. The H-O theorem:

A nation will export the commodity whose

production requires the intensive use of the
nation’s relatively abundant and cheap factor,
and import the commodity whose production
requires the intensive use of the nation’s relatively
scarce and expensive factor.

The relatively labor abundant nation exports the

relatively labor-intensive commodity and imports
the relatively capital-intensive one.
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FIGURE 5-3 General Equilibrium Framework of the

Heckscher-Ohlin Theory.

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FIGURE 5-4 The Heckscher-Ohlin Model.

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The (H-O) theory is based on two theorems:

2. The factor price equalization theorem:

International trade will bring about equalization in

the relative and absolute returns to homogenous
factors across nations.
International trade causes:
(w) to rise in Nation 1 (labour abundant nation
where wages are low) and fall in Nation 2 (the
capital-abundant nation where wages are high).
(r) to fall in Nation 1 (the K-expensive nation)
and rise in Nation 2 (the K-cheap nation).
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The (H-O) theory is based on two theorems:

2. The factor price equalization theorem:

Thus, international trade causes a redistribution of
income from the relatively expensive (scarce)
factor to the relatively cheap (abundant) factor.
International trade will be a substitute for
international mobility of factors.
Factor price equalization theorem holds only if
H-O theorem holds.
This theorem is also referred to as the Heckscher–
Ohlin–Samuelson theorem (H–O–S theorem).
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FIGURE 5-5 Relative Factor–Price Equalization.

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Empirical Tests of the H-O Model:

The Leontief Paradox:
The first empirical test of the H–O model was
conducted by Wassily Leontief in 1951.
Hypothesis: Since U.S. was the most K-abundant
nation in the world,, it was expected
p that the U.S.
exported K-intensive commodities and imported
L-intensive commodities.
Method: Leontief Calculated amount of labor and capital
in U.S. exports and import substitutes for year 1947.
Result: U.S. import substitutes were more K-intensive
than U.S. exports.
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Sources of the Leontief Paradox Bias:

Leontief used a two-factor model (L and K), thus

he neglected other factors such as natural
resources.
U.S. tariff p
policy:
y Labour-intensive industries in
U.S. were heavily protected. This reduced imports
of L-intensive goods and increased their domestic
production.
Leontief included in his measure of capital only
physical capital (as machinery and buildings),
and ignored human capital (education, skills and
job training).
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Empirical Tests of the H-O Model

Implications of the conflicting empirical results:

The H-O model is useful in explaining

international trade in raw materials and
agricultural
i lt l products
d t which
hi h represents
t a large
l
component of trade between developed and
developing countries.
There should be other basis for international
trade (Chapter 6).

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