Course Title:

International Economics

Instructor: Jia Huey (Jessica) Hsu

124116@mail.tku.edu.tw
Research Room: B1123

TLFBB4A
DIVISION OF GLOBAL COMMERCE,
DEPARTMENT OF INTERNATIONAL
BUSINESS
2022
 1

The Two-Factor Heckscher-

Ohlin Model
In today’s ➢ Explain how the Two-Factor
Heckscher-Ohlin Model works
class, you
will learn ➢ Discuss why the gains from trade
will not be equally spread
about:
➢ Identify the likely winners and losers
The Heckscher-Ohlin
Model

2
 In addition to differences in labor productivity, trade
occurs due to differences in resources across countries.

The Heckscher-Ohlin theory argues that trade occurs

due to differences in labor, labor skills, physical capital,
capital, or other factors of production across countries.

Introduction
 Why do Lower prices

countries Greater choice

trade Differences in resources

Economies of scale

Increased competition

More efficient allocation of resources

Source of foreign exchange

 Countries have different
relative abundance of
factors of production.
The Heckscher-Ohlin
Theory
Production processes use
factors of production with
different relative intensity.
The model shows that comparative advantage is influenced
by the interaction between nations’ resources and the
technology of production.
6
Assumptions of the Heckscher-
Ohlin Model

➢Two countries: Home and Foreign

➢Two goods: Cloth and Food
2 by 2 by 2
➢Two factors: Labor (L) and Capital (K)
➢The mix of labor and capital used varies
across goods

7
Assumptions of the Heckscher-
Ohlin Model

➢ The supply of labor and capital in each

country is constant and varies across
countries.
➢ In the long run, both labor and capital can
move across sectors, equalizing their returns
(wage and rental rate) across sectors.

8
Preview
✓ The production possibility frontier
without factor substitution
✓ Changing the mix of inputs
✓ Relationships among factor prices and
goods prices, and resources and
output
✓ Trade in the Heckscher-Ohlin model

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The production possibility frontier (PPF) without factor
substitution
The production The production
function for cloth function for food
Qc = Qc (KC, LC) QF = QF (KF, LF)

QC is total yards of cloth QF is total calories of food

production production
Kc and LC the amounts of KF and LF the amounts of K
K and L employed in and L employed in Food
cloth production production 10
The production possibility frontier (PPF) without
factor substitution
With more than one factor of production, the opportunity
cost in production is no longer constant and the PPF is no
longer a straight line.

aKC = capital used to produce one yard of cloth

aLC = labor used to produce one yard of cloth
aKF = capital used to produce one calorie of food
aLF = labor used to produce one calorie of food
11
Example:
Production possibilities describe different amounts of cloth and food
that can be produced, given factor endowments and technology.
K = 3000, total amount of capital available for production
L = 2000, total amount of labor available for production
Suppose use a fixed mix of capital and labor in each sector
aKC = 2 aLC = 2 aKF = 3 aLF = 1
Note: aKF / aLF > aKC / aLC
3/1 > 2/2
Therefore, production of food is capital-intensive and production of
cloth is labor-intensive. 12
Production possibilities are influenced by both capital
and labor:
• Capital used to produce cloth and food cannot exceed the
supply of capital available.
• Likewise, the labor used to produce cloth and food cannot
exceed the supply of labor available.

aKCQC + aKF QF  K aLCQC + aLF QF  L

aKC = 2 aKF = 3 aLC = 2 aLF = 1
13
 2QC + 3QF  3000 2QC + QF  2000

Capital constraint Labor constraint

➢Economy must produce subject to both constraints – i.e., it

must have enough capital and labor.
➢Without factor substitution, the production possibilities
frontier is the interior of the two factor constraints.

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 2QC + 3QF  3000 2QC + QF  2000
If all capital (K) used for cloth production 2QC  3,000 QC = 1,500
If all capital (K) used for food production 3QF  3,000 QF = 1,000
Same principle for Labor (L)
2QC  2,000 QC = 1,000
QF  2,000 QF = 2,000
If only produce food, it can produce 1,000 calories of food
0 + 3*1000  3,000 (K)
0 + 1,000  2,000 (L) have spare labor resources
If only produce cloth, it can produce 1,000 yards of cloth
2 *1,000 + 0  3,000 (K) have spare capital resources
2*1,000 + 0  2,000 (L) 15
2QC + 3QF  3000
System of equations
2QC + QF  2000

➢ The economy can’t use more than the available supply of

labor (2,000 work-hours) or capital (3,000 machine-hours)
➢ At production point 3, the economy uses all of its labor and
capital resources. Only at this point will all resources be
used.
➢ Solve the above system of equations. We arrive at QC = 750
and QF = 500
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Figure 5.1 The Production Possibility Frontier without Factor Substitution
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.112. 17
The opportunity cost of producing one more yard of cloth,
in terms of food, is not constant:
2 
• low 3 in example  when the economy produces a low
 
amount of cloth and a high amount of food
• high (2 in example) when the economy produces a high
amount of cloth and a low amount of food
Why? Because when the economy devotes more resources
towards production of one good, the marginal productivity of those
resources tends to be low so that the opportunity cost is high.

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➢ The above PPF equations do not allow
substitution of capital for labor in
production.
➢ Unit factor requirements are constant
along each line segment of the PPF.

19
 ➢ If producers can substitute
Given one input for another in the
substitution is production process, then
now possible the PPF is curved
(bowed).
➢ Opportunity cost of cloth
increases as producers
make more cloth.

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 If capital can be
substituted for labor
and vice versa, the
production possibility
frontier no longer has
a kink.

Figure 5.2 The Production Possibility Frontier with Factor Substitution

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.113. 21
 ➢ The economy produces
at the point that
maximizes the value of
production given the
prices it faces; this is the
point on the highest
possible isovalue line.
➢ An isovalue line is a line
representing a constant
value of production, V:
V = PCQC + PF QF

Figure 5.3 Prices and Production

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.114. 22
 Choosing the Mix of Inputs
23

➢ Producers may choose different amounts of

factors of production used to make cloth or
food.
➢ Their choice depends on the w /r
➢ As the wage w increases relative to the
rental rate r, producers use less labor and
more capital in the production of both food
and cloth.
 At any given wage-rental
ratio, cloth production uses
a higher labor-capital ratio:
cloth production is labor-
intensive
food production is capital-
intensive.

FF &CC: relative factor

demand curves
Figure 5.5 Factor Prices and Input Choices
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.115. 24
 The higher the relative
cost of labor, the higher
the relative price of the
labor-intensive good.

Given cloth is relatively

more labor-intensive, an
increase in the relative price
of labor (w/r) will increase
the relative price of cloth.
Figure 5.6 Factor Prices and Goods Prices
Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.116. 25
 ➢ When the relative
price of cloth
(Pc/PF) increases,
both the
production of
cloth and food
uses less L/K
➢ If Pc/PF rises, the
wage-rental ratio
must rise

Figure 5.7 From Goods Prices to Input Choices

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.117. 26
27
Stolper-Samuelson theorem:
If the relative price of a good increases, then the real
return ( the real wage or rental rate) of the factor used
intensively in the production of that good increases,
while the real return to the other factor decreases.

Any change in the relative price of goods alters the

income distribution.
Resources and Output

Assume an economy’s labor force grows

Expansion of production possibilities is

biased toward cloth

At a given relative price of cloth, the

ratio of labor to capital used in both
sectors remains constant
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 An increase in the supply
of labor shifts the
economy’s production
possibility frontier outward
disproportionately in the
direction of cloth
production. At an
unchanged relative price of
cloth, food production
declines.

Figure 5.8 Resources and Production Possibilities

Source: Krugman, P., Melitz, M., & Obstfeld, M. (2018).International Economics: Theory and Policy, 11th Edition, Global Edition.
Pearson, p.119. 29
➢ An economy with a high ratio of
labor to capital produces a high
output of cloth relative to food
➢ Suppose that Home is relatively
abundant in labor and Foreign in Resources
capital and Output
➢ Home will be relatively efficient at
producing cloth because cloth is
relatively labor intensive

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 31

Heckscher-Ohlin theorem: The

Trade in the country that is abundant in a factor
Heckscher-Ohlin exports the good whose production
Model is intensive in that factor.
Countries tend to export goods
The countries are
assumed to have the whose production is intensive in
same technology and factors with which the countries
the same tastes. are abundantly endowed.
 32

➢ Owners of a country’s abundant

Trade and the factors gain from trade, but
Income owners of a country’s scarce
Distribution factors lose.
➢ Factors of production that are
International trade can
used intensively by the import-
affect the distribution of
income (even in the
competing industry are hurt by
long run) the opening of trade – regardless of
the industry in which they are employed.
Example
• Comparing the United States and Mexico, we observe a relative
abundance of capital in the United States and a relative abundance of
labor in Mexico.
• Thus, goods that intensively use capital in production should be cheaper
to produce in the United States, and those that intensively use labor
should be cheaper to produce in Mexico.
• With trade, the United States should export capital-intensive goods like
computers, while Mexico should export labor-intensive goods like
textiles. With integrated markets, international trade should lead to a
convergence of goods prices. Thus, the prices of capital-intensive goods in
the United States and labor-intensive goods in Mexico will rise.

33
Example
• According to the Stolper-Samuelson effect, owners of a country’s abundant
factors (e.g., capital owners in the United States, labor in Mexico) will gain
from trade, while owners of the country’s scarce factors (labor in the United
States, capital in Mexico) will lose from trade.
• Theoretically, the gains from trade could be
redistributed such that everyone is better off; however,
such a plan is difficult to implement in practice.

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 Exercise
1. In the 2-factor, 2-good Heckscher-Ohlin model, the
production possibility frontier is kinked when
(A) the opportunity cost of production is constant.
(B) there is no factor substitution in production.
(C) there are unemployed factor resources.
(D) a country does not engage in trade.
Answer: 35
 Exercise
1. In the 2-factor, 2-good Heckscher-Ohlin model, the
production possibility frontier is kinked when
(A) the opportunity cost of production is constant.
(B) there is no factor substitution in production.
(C) there are unemployed factor resources.
(D) a country does not engage in trade.
Answer: B 36
 Exercise
2. In the 2-factor, 2-good Heckscher-Ohlin model, the
country with a relative abundance of ________ will
have a production possibility frontier that is biased
toward production of the ________ good.
(A) labor; labor intensive (B) labor; capital intensive
(C) land; labor intensive (D) land; capital intensive
Answer:
37
 Exercise
2. In the 2-factor, 2-good Heckscher-Ohlin model, the
country with a relative abundance of ________ will
have a production possibility frontier that is biased
toward production of the ________ good.
(A) labor; labor intensive (B) labor; capital intensive
(C) land; labor intensive (D) land; capital intensive
Answer: A
38
 Exercise
3. According to the Stolper-Samuelson theorem, if
the relative price of a good increases, then the real
return of the factor used intensively in the production
of that good , while the real return to the other
factor .
(A) increases, decreases (B) decreases, increases
(C) increases, increases (D) decreases, decreases
Answer: 39
 Exercise
3. According to the Stolper-Samuelson theorem, if
the relative price of a good increases, then the real
return of the factor used intensively in the production
of that good , while the real return to the other
factor .
(A) increases, decreases (B) decreases, increases
(C) increases, increases (D) decreases, decreases
Answer: A 40
 Exercise
4. The Heckscher-Ohlin model predicts all of the following
EXCEPT
(A) that trade increases a country's overall welfare.
(B) which factor of production within each country will
gain from trade.
(C) which country will export which product.
(D) the volume of trade. Answer: 41
 Exercise
4. The Heckscher-Ohlin model predicts all of the following
EXCEPT
(A) that trade increases a country's overall welfare.
(B) which factor of production within each country will
gain from trade.
(C) which country will export which product.
(D) the volume of trade. Answer: D 42
 Exercise

5. If Australia has relatively more land per worker, and Belgium has relatively
more capital per worker, then if trade began between these two countries
(A) the relative price of the capital-intensive product would decrease in Belgium.
(B) the relative price of the land-intensive product would increase in Australia.
(C) the relative price of the land-intensive product would increase in Belgium.
(D) the relative price of the capital-intensive product would increase in Australia.
Answer:

43
 Exercise

5. If Australia has relatively more land per worker, and Belgium has relatively
more capital per worker, then if trade began between these two countries
(A) the relative price of the capital-intensive product would decrease in Belgium.
(B) the relative price of the land-intensive product would increase in Australia.
(C) the relative price of the land-intensive product would increase in Belgium.
(D) the relative price of the capital-intensive product would increase in Australia.
Answer: B

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