Group No.

12

The Heckscher-
Ohlin Model

Made by: Phalit Gupta 46

Prajwal Choudhary 48
Payal Kumari 45
Pradnya Salve 47
Evolution of H.O theory
Bertil Ohlin in his famous book Inter-regional and
International Trade (1933) criticized the classical theory of
international trade and formulated the General
Equilibrium or factor endowment theory. It is also known
as Heckscher – Ohlin theory.
In fact Eli Heckscher, Ohlin’s teacher, who first
propounded the idea in 1919 that trade results from
differences in factor endowments in different countries,
and Ohlin carried it forward to build the modern theory of
international trade.
Introduction
• H-O theory of international trade which is essentially the modern theory
of comparative advantage. And, like the Ricardian theory, the H-O theory
explains the basis of trade between two countries by focusing on
differences in supply conditions.
• Eli Heckscher and Bertil Ohlin explained the basis of trade between two
countries on the basis of differences in relative factor endowments.
• The H.O theory states that the main determinant of the pattern of
Production, Specialisation and trade among regions is the relative
availability of factor endowments and factor prices.
• “Some countries have much capital, others have much labor. The theory
now says that countries that are rich in capital will export capital-
intensive goods and countries that have much labor will export labour-
intensive goods.”
Assumptions of the Model
1) There are two nations (1&2), two commodities (X&Y), two factors of
production (labor & capital).
Means Used to illustrate the theory in a two-dimensional figure.

2) Both nations use the same technology in production.

Means both nations have access to and use the same general
production techniques.

3) Commodity X is labor intensive and Y is capital intensive in both

nations.
Means the labor-capital ratio (L/C) is higher for X than Y in both nations
at the same relative factor prices.
4) Both commodities are produced under constant returns to scale in both nations.

Means that increasing the amount of l and c will increase output in the same proportion

5) There is incomplete specialization in production in both nations.

Means that even with free trade both nations continue to produce both commodities. This
implies neither nation is very small.

6) Tastes are equal in both nations.

Means demand preferences are identical in both nations. When relative prices are equal in the
two nations, both consume x&y in the same proportion.

7) There is perfect factor mobility within each nation but no international factor mobility.
Means c&l are free to move from areas and industries of lower earnings to those of higher
earnings until earnings are the same in all areas, uses and industries of the nation. International
differences in earnings persist due to zero international factor mobility in the absence of
international trade.
7) there is perfect competition in both commodities and factor markets in both
nations.
Means that producers, consumers, and traders of x&y in both nations are each too
small to affect prices of commodities.
9) There are no transportation costs, tariffs, or other obstructions to the free flow of
international trade.
Means specialization in production proceeds until relative (and absolute) commodity
prices are the same in both nations with trade. If transportation costs and tariffs were
allowed, specialization would proceed only until prices differed by no more than the
costs and tariffs on each until of the commodity traded.
10) All resources are fully employed in both nations.
Means there are no unemployed resources in either nation.
11) International trade between the two nations is balanced.
Means that the total value of each nation’s exports equals the total value of the
nation’s imports.
Explanation
• Suppose nation 1 is labor
abundant nation and nation 2
is capital abundant nation.

• Let production of product X be

labor intensive and that of
product Y is capital intensive.

• The PPF’s shown in following

figure show the max. limit of
production of X & Y, possible
with given resources.
 For example
IF WE IMAGINE COMMODITY X IS LABOR INTENSIVE COMMODITY AND NATION 1
PRODUCES IT, ON THE OTHER HAND NATION-2 PRODUCES COMMODITY Y WHICH IS
CAPITAL INTENSIVE COMMODITY. HERE L IS AVAILABLE AND CHEAP FACTOR IN NATION 1
AND SO IS K IN NATION 2.
NOW H-O THEOREM SAYS THAT, NATION-1 WILL EXPORT
X BECAUSE X IS THE L-INTENSIVE COMMODITY AND L IS
RELATIVELY ABUNDANT AND CHEAP FACTOR IN NATION
1.

NATION 1

AND NATION-2 WILL EXPORT Y BECAUSE Y IS THE K-INTENSIVE

COMMODITY AND K IS RELATIVELY ABUNDANT AND CHEAP
FACTOR IN NATION 2. .
NATION 2
Pre and Post-Trade Situation
 Before trade, both nations will have different price ratios of X & Y commodities such
as PA and PA` respectively.

 Both nations must produce on their production possibility curve, where their
respective price line is tangent to the production possibility curve.

 This happens at point A for nation 1 and on A` for nation 2, yet they are not trading,
so consumption will be at the same points.

 There are no imports or exports.

 This concept is explained by following figure Left side panel.

• Since the two nations have equal tastes, they face the same indifference map.

• Indifference curve I is the highest IC that Nation 1 and Nation 2 can reach in isolation,
and points A and A` represent their equal. points of production and consumption in
the absence of trade.

• The tangency of IC I at points A and A` defines the no-trade equal-relative commodity

prices of PA in Nation 1 and PA` in Nation 2.

• Since PA < PA` , Nation 1 has a com-adv. in X and Nation 2 has a com-adv. in Y.
• Right panel shows the after trade situation where nation 2 is producing capital
intensive commodity Y & nation 1 is producing labor intensive commodity X, more
than pre-trade situation.
• Production of nation 1 & 2 are shown by points B & B` respectively.
• The point of consumption is E` on a higher Indifference curve
• Nation 1 exports X in exchange for Y and consume at point E on IC II. Nation 2
exports Y for X and consume at point E` (which coincides with point E).
• Note that Nation 1’s exports of X equal Nation 2’s imports of X (i.e. BC=C ` E `).
• Similarly, Nation 2’s exports of Y equal Nation 1’s imports of Y (i.e. B ` C ` =C E).
• After the trade, both the countries will have both types of goods
at the least cost.
• As a result the welfare of both nations will be increased, as after
trade they are consuming at a higher indifference curve.
Limitations of theory
• The theory holds good if the capital abundant country has a
distinct preference for the labour intensive goods and the
labour abundant country has a distinct preference for capital
intensive goods.
• Again the theory does not hold good if the labour abundant
country is technologically advanced in capital intensive
goods or if capital abundant economy is technologically
advanced in the production of labour intensive goods.