Chapter 5 Factor Endowments and the Heckscher–Ohlin Theory
The Heckscher–Ohlin theory is based on the following assumptions:
1. There are two nations (Nation 1 and Nation 2), two commodities (commodity X and
commodity Y), and two factors of production (labor and capital).
2. Both nations use the same technology in production.
- factor prices usually differ
- producers in each nation use more of the relatively cheaper factor in the nation to
minimize their
costs of production
3. Commodity X is labor intensive, and commodity Y is capital intensive in both nations.
4. Both commodities are produced under constant returns to scale in both nations.
- the output will increase by the same proportion with the increased input
5. There is incomplete specialization in production in both nations.
- a nation that produces based on incomplete specialization indicates the nation is the
large nation
6. Tastes are equal in both nations.
- Indifference curve is the same, IC reflects on preferences
- PX/PY (relative commodity price) are the same
- both nations will consume and produce X and Y in the same proportion.
7. There is perfect competition in both commodities and factor markets in both nations.
- Consumers, producers and traders for commodity X and Y in both nations are each too
small to affect the prices
- Price taker, in the long run commodity price equal cost of production (P=ATC)
- Earn zero economic profit
- producers, consumers, and owners of factors of production have perfect knowledge of
commodity prices and factor earnings
8. There is perfect factor mobility within each nation but no international factor mobility.
- labor and capital are free to move from areas and industries of lower earnings to areas
and industries of higher earnings
- Stop mobility until earnings for the same type of labor and capital are the same in all
areas, uses, and industries of the nation
- zero international factor mobility (no mobility of factors among nations)
- international differences in factor earnings would persist in the absence of
international trade
9. There are no transportation costs, tariffs, or other obstructions to the free flow of
international trade.
- specialization in production proceeds until relative (and absolute) commodity prices
are the same in both nations with trade
- specialization would proceed only until relative (and absolute) commodity prices
differed by no more than the costs of transportation and the tariff on each unit of the
commodity traded
10. All resources are fully employed in both nations.
- no unemployed resources or factors
11. International trade between the two nations is balanced.
- total value of each nation’s exports equals the total value of the nation’s imports
 Factor Intensity
- K/L L/K
- w/r
 Heckscher–Ohlin (H-O) theory
- based on two theorems (H-O and factor price equalization)
 The Heckscher–Ohlin 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.
- In short, the relatively labor-rich nation exports the relatively labor-intensive commodity
and imports the relatively capital-intensive commodity.
-
The H–O theorem explains comparative advantage rather than assuming it
 Export commodity which has comparative advantage
 Import which has comparative disadvantage
 Difference in relative factor abundance and prices (factor endowments) is the cause
of the pre-trade difference in relative commodity prices between two nations.
o Pre-trade price differential e.g. (PX/PY) lower, export x
 This difference in relative factor and relative commodity prices is then translated into
a difference in absolute factor and commodity prices between the two nations
 It is this difference in absolute commodity prices in the two nations that is the
immediate cause of trade.
 The Factor–Price Equalization Theorem
- International trade will bring about equalization in the relative and absolute returns to
homogeneous factors across nations
-
International trade will cause the wages of homogeneous 均匀的 labor (i.e., labor with
the same level of training, skills, and productivity) to be the same in all trading nations
Similarly, international trade will cause the return to homogeneous capital (i.e., capital of
the same productivity and risk) to be the same in all trading nations.
That is, international trade will make w and r the same in both nations.
Both relative and absolute factor prices will be equalized.