8. The Heckscher-Ohlin model - WIF

8. The Heckscher-Ohlin model
8.1. Introduction
The Heckscher-Ohlin model departs from the Ricardo model in two respects:
[1] There are two factors of production (capital and labour) and
[2] the production technologies are identical in both countries.
Adding a second factor leads to much richer and more realistic explanations of trade and its consequences. First, the
PPF becomes concave, reflecting rising OC. Hence, countries will produce both goods rather than specializing completely.
Second, even though countries enjoy aggregate gains from trade, free trade causes a redistribution of real
income between capital and labor.
In the Heckscher-Ohlin model, comparative advantages and trade are determined by international differences in factor
endowments.
8.2. The effects of endowment differences
Basic assumptions:
[1] The production functions for good X and Y exhibit CRS. The production functions are the same across countries
and differ in usage of capital and labor. Specifically, we will take good X to be labor-intensive and good Y to be
capital-intensive.
[2] Total supply of the two factors is fixed. Input factors are homogenous and completely mobile across industries.
However, capital and labor are perfectly immobile across countries.
[3] There are no market distortions such as imperfect competition, labor unions or taxes. Full employment prevails.
[4] Preferences are identical in both countries and homogenous.
[5] Countries differ in their relative factor endowments (this is the only difference between countries).
Factor endowments
Factor endowment is defined by the ratio of capital to labor. If the capital-labor ratio in Country H is greater than in
Country F, Country H is said to be relatively capital-abundant (and labor-scarce), while Country F is labor abundant
(and capital-scarce). This can be stated as
HK ê LL h > HK ê LL f .
(1)
An illustration of real world factor endowments is given in Table 8.1.
see Table 8.1
Important implication of different factor endowments for autarky factor prices: For two countries with identical
demand patterns, relative factor prices should reflect relative factor scarcities. Country F would have relatively inexpensive
labor and Country H would have relatively inexpensive capital.
Factor intensities

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Good Y is relatively capital-intensive and good X is relatively labor-intensive if the capital-labor ratio used in production
is higher in the Y -sector
HK ê LL y > HK ê LL x .
(2)
In equilibrium, both sectors choose capital-labor ratios that minimize costs taking the prevailing relative factor price
w=w ê r into account (the choosen capital-labor ratio is endogenous). In principle, the factor intensities could be
reversed when factor prices change. We assume here that this is not the case (no factor intenstity reversal).
Table 8.2 presents estimates of capital-labor ratios in certain U.S. manufacturing industries in 1984.
see Table 8.2
Implications
Consider the endowment represented by point E in Figure 8.1 (L êê and K êê ). The associated maximum quantities of X
and Y are X êêê and Y êê as shown in Figure 8.2. The complete PPF is Y
êê X
êêê . (E will be E f in the argumentation below)
Now consider the endowment E h . Once more, the maximum level of output (isoquants in Figure 8.1) is indicated by
Y êê
h and X êêê h in Figure 8.2. The corresponding PPF is Y êê h X êêê h . Compared to F, more Y (capital-intensive good) and less
X (labor-intensive good) can be produced.
see Figure 8.1
see Figure 8.2
Scale invariance: Notice that the scale of the economies does not influence the basic argument according to which
relative factor endowment is crucial for comparative advantages. This is due to the fact that the production functions
are assumed homogenous.
Figure 8.3 reproduces the PPFs of the two countries together with a set of (identical) indifferences curves, reflecting
identical and homogenous preferences.
see Figure 8.3
In addition, the autarky equilibrium points are shown. Notice that in autarky we have
p h > p f .
(3)
Recall that p := p x ê p y , i.e. X is relatively expensive at H and relatively cheap at F (vice versa for Y ).
Because of homogeneity of production functions and preferences, these relative autarky prices would be the same
regardless of country size (equilibrium points would lie along rays 0A h and 0A f generating the same prices). Absolute
size is irrelevant for the determination of comparative advantage in the HO model. What matters are relative factor
endowments and factor intensities.
8.3. The Heckscher-Ohlin theorem
What are the consequences of opening up the economies in an HO world?
In autarky, p h > p f . With international trade, the residents of H have incentives to purchase X abroad (in F) and,
analoguosly, the residents of F will purchase Y in country H. This applies as long as p h > p f .
This demand shift induces a change in commodity prices and thereby a change in national production structures. The
production point in H (F) will shift toward the Y (X ) axis. As a result, p h decreases and p f increases. In an international
equilibrium, commodotity prices are equalized in the two countries p * = p h = p f .
An international equilibrium additionally requires that world commodity markets clear. For each good, excess demand
from one country must equal excess supply from the other country. In Figure 8.4, the trade triangles must be of
identical size.

Class_7.nb 3
see Figure 8.4
Both economies consume on indifference curves that lie outside their PPF. Therefore, free trade in the HO model
provides aggregate gains from trade for each country.
Heckscher-Ohlin theorem
Given the assumptions of the model (stated above), a country will export the commodity that intensively uses its
relatively abandunt factor.
By virtue of exporting the capital-intensive good and importing the the labor-intensive good, Country H implicitly
exports the services of capital. International trade in commodities accomplishes the task of exchanging surplus factor
services between countries.