Hecksher - Ohlin

theory & Leonteif

Paradox
Presented by - Soumya Srijan (99)
Kashish Verma (37)
Soumya Sharma (100)
 Table of
CONTENTS
01 02
Hecksher- ohlin Genral Equilibrium
framework
theory

03 04
Factor Price Equilisation Leonteif Paradox
Theorem

The hecksher -
Ohlin Theory
The Hecksher- Ohlin theory of international trade also
known as the Moder theory of comparative
advantage, explains the basis of trade between two
countries by focusing on differences in relative factor
endowments.
According to Hecksher and Ohlin, the difference in
factor endowments are the basis of international
trade. Different countries differ in efficiency in
production of different commodities resulting in
advantage in exchange. Such differences are caused
by the following factors :
Firstly,
climatic and geographical conditions differ widely among region to region. For
example, countries like Bangladesh has favorable climatic and geographical
conditions for production of jute whereas Egypt for rice and cotton.
Secondly,
human capabilities are different in different countries. Some races are considered
to be physically sturdy while others are intellectually alert, some posses super
dexterity and manual skills, while other exceed in entrepreneurial and
organizational skills.
Thirdly,
There are differences in the proportions between different types of resources in
different countries. For instance, Australia has vast plains but fewer people and
capital goods. That's why it is better for them to specialize in commodities which
require high proportion of land but lower amount of labour and capital goods
 Assumptions of
H-O Theory
It is a two-by-two-by-two model, there There is free and unrestricted trade

01 are two countries, two commodities and

two factors of production (capital and
02 between the two countries.

labour).

Taste and preferences of consumers and

The production functions of the two

03 04
their demand patterns are identical in
commodities have different factors
both the countries.
intensities i.e, labour and capital.
 There is no any change in technological There is incomplete specialization. Neither

05 knowledge .
06 country specializes in the production of
the commodity.

The factors of production are movable

There are no transportation costs.

07 08
within their respective countries but are
immovable between countries.
 INTERPRETATION
The theory was developed by Swedish economist,
Berlin Ohlin.As per the theory different countriesare
endowed with differentfactorsof production, certain
countries have higher supply of capital whereas the
other countries have large supplyof labour. Such
differencein factors causes the variation in price of
factors due to which the cost of goods varies.
So, the countriesin which capital is relatively plentiful
and labour is relatively scarce will tend to export capital
intensive products and import labour intensive products.
while the countries having labour plentiful and capital
relatively scarce will tend to export labour intensive
products and import capital intensive products.
.
 FOR EXAMPLE
Country A have 2000cr Capital and 500 units of Labour
Country B have 500cr Capital and 2000 units of labour.
Ratio of Capital and labour of Country A is 4, i. e, Country A have 4 Capital per labour.
Ratio of Capital and labour of Country B is. 25, i.e, Country B have .25 Capital per labour.
Hence, Country A is abundant in Capital than Country B and Country B is abundant in
labour. So, Country A will produce more capital intensive goods like watches and export
to Country B and Country B will produce more labour intensive goods like cloth and
export to Country A.
 GENERAL
EQUILIBRIUM
The general Equilibrium model under the hecksher ohlin
theory shows how the economic forces jointly
determine the price of final commodities. The
distribution in the ownership factors of productionand
the tastes come togetherand determine the demand for
the final commodity. The demandfor the final
commodities determines the derived demand for the
factors of production. The factors of productionalong
with their supply determines the price of these factors
of production under perfect competition. The price of
factors of the production with the given level of
technology determine the price of final commodity.
.
 FACTOR PRICE EQUILISATION
THEOREM
This theory was an important extension of H O theory of trade.

.
Heckscher-Ohlin model emphasizes the export of goods
requiring factors of production that a country has in
abundance.

The factor price equalisation theory is an important corollary of

the H-O theory of trade.
If there is a free international movement of factors, the prices
of the factors of production undisputably get equalised.

However, the classical theorists as well as Heckscher and Ohlin

had assumed an international immobility .of factors.

This led to the crucial question of how the international trade

would affect the prices of the factors of production.
•
 Export Perspective
The factor price equalisation theory picks up the argument that
the labour-abundant counto specialises in the export of the
labour-intensive commodity because labour is a relatively
.
cheaper factor compared with capital.

On the other hand, the capital-abundant country specialises in

the export of capital-intensive commodity on account of capital
being a relatively cheaper factor there.

The pressure of international demand renders the abundant

factor scarce and its price starts rising.
Import Perspective
At the same time, the import of the commodities that require
more input of scarce factor relieves the domestic pressure of
demand for that factor, resulting in a fall in its price.
.

The process of change in prices of factors will ultimately bring

about an equality in the prices of factors.

It is in this sense that free international trade in commodities

acts as a substitute for the international mobility of factors.
 IMPORTANT FACTS
FPE theory argument that the labor
- abundant
abundant country specialises in the
exbort of the labor intensive
goods because labor cheaber factor
compared with
capital and vice-versa.
Due to pressure of international
demand the abundant factor prices
starts rising.
Due to international trade
After trade
Abundant facton prices rises.
scarce factor prices falls.
 LEONTIEF
PARADOX
• Wassily Leontief was a Russian-American economist
who made several
contributions to the world of economics.
Leontief won the Nobel Prize in 1973 for his
research on input-output analysis.
Leontief was also credited with the Leontief
Paradox and the Composite Commodity theorem

What is
LEONTIEF PARADOX
The Leontief Paradox refers to the
unexpected findings by economist
Wassily Leontief in the 1950s. He
observed that the United States, which
was abundant in capital, was exporting
goods that were less capital-intensive
and importing goods that were more
capital-intensive, contrary to what the
Heckscher-Ohlin model predicted
The Leontief Paradox, as it came to be
known, led many economists to question
the Heckscher-Ohlin Theorem, which
states that countries produce and export
what they can create most efficiently,
depending on their factors of production.
Moreover, they import goods that they
cannot produce as efficiently
"An attempt to test the consistency of the
H-O Model with the US Trade Pattern"
Objective was
To Prove that H-O model was correct
To show that US Export were capital
intensive
FIRST EMPIRCAL TEST OF H.O THEORY
FOR EXAMPLE
Used 1947 input output table of the US
economy
Leontief reached a paradoxical
conclusion that the US-the most capital
abundant country in the world by any
criterion -exported labor-intensive
commodities and imported capital-
intensive commodities. This result has
come to be known as the Leontief
Paradox.
 Capital and Labor Requirements to produce one million dollars'
worth of the typical exportable and importable bundles in 1947.

Capital Labour
requirement requirement

Exports Akx = 2.550780 Alx= 182.313 man-years

Imports Akm = 3.091339 Alm = 170.114 man-years

Leontief was surprised to discover that US imports were 30% more

capital-intensive than US export
Leontief’s Second Test
In 1956 Leontief repeated the test for US imports and exports which
prevailed in 1951.
In his second study, Leontief aggregated industries into 192
industries.
He found that US imports were still more capital-intensive than US
exports. US imports were 6% more capital-intensive (Km = 1.06 kx).
 Criticism
Homogeneous Factors: Assumes factors of production are homogeneous within each country, ignoring variations in skills,
technology, and capital quality.

Immobility of Factors: Ignores the mobility of factors within countries, which can lead to more complex trade patterns
than predicted.

Constant Returns to Scale:Assumes constant returns to scale in production, overlooking economies of scale, which can
affect comparative advantage.

Limited Product Differentiation:Doesn't account for product differentiation, which can influence trade patterns based on
consumer preferences.

Technological Differences: Doesn't consider differences in technology levels across countries, which can impact factor
intensities and trade patterns.

Dynamic Changes: Doesn't account for changes over time, such as technological advancements or shifts in comparative
advantage, leading to potential discrepancies between theory and reality.
 LEONTIEF MODEL VS HECKSCHER-OHLIN

It was considered that a country will tend to export those

commodities which use its abundant factors of production
intensively and import those which use its scarce factor
intensively (HO)
By common consent the United States is the country that is
most abundantly endowed with capital. Therefore, it is
expected the US to export capital intensive goods and import
labour intensive goods
The Leontief conclusion that in the international division of
labour, the US specialized in labour intensive rather than
capital intensive goods contradicted the widely accepted
view derived from the HO
THANK YOU
GROUP MEMBERS

Soumya srijan
(roll no. 99)

Kashish verma
(roll no. 37)

Soumya sharma
(roll no. 100)