School of International Trade and Economics, Guangdong University of Foreign Studies
广东省精品课程《国际贸易》
CH4 Neo-classical Trade Theories
刘
芹
Chapter 4
The Basic Model of
Neoclassical Trade
Theories
H-O Model
After studying this chapter, you should be
able to:
(1) Understand the concepts of factor
abundance(要素丰裕度) and factor
intensity(要素密集度)
(2) Know what the factor proportion(要素比例论)
or the Heckscher-Ohlin theory postulates
(3) Explain how international trade affects the
income distribution: specific theorem and
Stolper-Samuelson theorem
(4) Know some empirical tests of the H-O
theory: Leontief Paradox(里昂惕夫之谜)

H-O model, Factor Endowment Theory
H-O Theorem
Factor-price Equalization theorem
Factor Growth and IT
Empirical Tests of H-O Model
Rybzynski Theorem
Leontief Paradox and its Explaination
§1 Introduction
 In this chapter, we extend our trade model
in two important directions:
 First, we explain the basis of (i.e., what
determines) comparative advantage. We’ll
go one step further and explain the reason,
or cause, for the difference in relative
commodity prices and comparative
advantage between the two nations.
 The second way is to analyze the effect that
international trade has on the earnings of
factors of production in the two trading
nations. That is, we’ll examine the effect of
intl trade on the earnings of labor and
capital, as well as intl differences in
earnings.
 Heckscher-Ohlin (H-O) theory postulates
that (1) a nation exports commodities
intensive in its relatively abundant and
cheap factor and (2) international trade
brings about equalization (均等化) in returns
to homogeneous(同质的) factors across
countries.
 So, the H-O theory can be expressed in the
form of two theorems: the so-called H-O
theorem (which deals with and predicts the
pattern of trade) and the factor–price
equalization theorem(要素价格均等化定理) (HO-S theorem) (which deals with the effect of
international trade on factor prices).
 Eli F Heckscher (1879-1959）
was born in Swedish
Jewish family. His greatest
contribution was that he
introduced quantitative(定量
的) analysis. In 1919, He
published his classical
work The Effect of Foreign
Trade on the Distribution of
Income and explore the
core of Factor Endowment
Theory ------ the difference
in factor endowment is the
basis for comparative
advantage and international
trade.
 In 1933, Ohlin, another
Swedish economist and
former student of
Heckscher, published his
famous book
“Interregional and
International Trade”,
further explaining his
teacher’s theory and
completing factor
endowment theory. He
was awarded the 1977
Nobel prize in economics
for his contribution to the
theory of international
trade.
• Paul Samuelson (1915--2009), 1970 Nobel Prize in
economics.
• "International Trade and the
Equalization of Factor
Prices", 1948
• “Factor Price and
Commodity Price in the
General Equilibrium”, 1953
• Factor-price equalization
theorem is referred to as the
H-O-S theorem
§2 Heckscher-Ohlin Factor
Endowment Trade Model
2.1 Assumptions of H-O
Model:
(1) two nations(1, 2), two
commodities (X,Y), and
two factors of production
(labor ,capital);
(2) Both nations use the
same technology in
production;
(3) In both nations, X is
labor-intensive (i.e., the
ratio of labor to capital in
the production of X is
greater than in Y); Y is
capital-intensive;
(4) Both commodities are produced under
constant returns to scale(规模报酬不变);
(5) There is incomplete specialization(不完全的专业
化生产) in production);
(6) Tastes are same in both nations;
(7) There is perfect competition in both
commodity and factor markets;
(8) There is perfect factor mobility within each
nation but no international factor mobility;
(9) There is no transportation costs, tariffs, or
other obstructions to the free flow of
international trade;
(10) All resources are fully employed;
(11) Trade is balanced.
2.2 Factor Endowments and Relative Supply
2.2.1 Factor Intensity
 It measures the input ratio of production
factors in the production. That is, factor
intensity is measured by the ratio of capital
to labor putting into the production.
 If the capital-labor ratio (K/L) used in the
production of Y is greater than that in X,
commodity Y is capital-intensive and
commodity X is labor-intensive.
 It is not the absolute amount of capital and
labor used in the production of commodities,
but the amount of capital per unit of labor
(K/L).
In Nation 1, K/L in X: 1/4 ; in Y : 1
In Nation 2, K/L in X: 1 ;in Y:4
So, X is L- intensive commodity;
Y is K-intensive
So, X is L-intensive commodity, Y
is K-intensive
• Why does Nation 2 use more K-intensive
production techniques in both commodities than
Nation 1 ?
 The answer is that capital must be relatively
cheaper in Nation 2 than in Nation 1, so that
producers in Nation 2 use relatively more
capital in the production of both
commodities to minimize their costs of
production.
 Why is capital relatively cheaper in Nation 2 ?
 To answer this question, we must define
factor abundance and examine its
relationship to factor price.
2.2.2 Factor Abundance
• It measures the relative abundance of one
nation’s economic resources.
a. physical units （ 实 物 单 位 ） : the overall
amount of capital and labor available to
each nation.
Nation 2 is capital-abundant if (TK/TL)2>(TK/TL)1
b. relative factor prices: the rental price of
capital and the price of labor time in each
nation.
Pk/Pl=r/w
r: interest rate; w: wage rate
Nation 2 is capital-abundant if (r/w)2<(r/w)1.
• In terms of physical units, the definition of
factor abundance considers only the supply
of factors. But in terms of relative factor
prices, the definition considers both demand
and supply.
• Since we have assumed that tastes, or
demand preferences, are the same in both
nations, the two definitions of factor
abundance give the same conclusions in our
case.
2.2.3 factor abundance and the shape
of the production frontier
Y
Nation 1 is the L-abundant
nation and X is the L-intensive
commodity. So, Nation 1 can
Nation 2
Nation 1
produce relatively more commodity
X. The PPF of Nation 1 is relatively
flatter and wider than Nation 2’s. it
is skewed toward the horizontal
axis which measures commodity X.
X
2.3 Heckscher-Ohlin Theorem
 H-O theorem, the part of H-O theory,
postulates that 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.
 Of all the reasons for differences in relative
commodity prices and comparative advantage
among nations, the H-O theorem isolates the
difference in relative factor endowments among
nations as the basic cause of comparative
advantage and international trade. For this
reason, the H-O model is often referred as the
factor-proportions or factor-endowment theory.
CASE STUDY 4-1
 Each nation should specialize in the
production of and export the commodity
intensive in its relatively abundant and
cheap factor and imports the commodity
intensive in its relatively scarce and
expensive factor.
2.3.1 Illustration of the H-O theory
 Indifference curve I and II are common to both
nations because of the assumption of equal
tastes. Indifference curve I is tangent to the PPF
of Nation 1 at point A and tangent to the PPF of
Nation 2 at A’. This defines the no-trade
equilibrium relative commodity price of PA=1/2
in Nation 1 and PA’=2 in Nation 2. Since PA < PA’ ,
Nation 1 has a comparative advantage in
commodity X and Nation 2 in commodity Y. With
trade (see the right panel) Nation 1 produces at
point B and by exchanging 40X for 45Y reaches
point E in consumption (see trade triangle BCE).
Nation 2 produces at B’ and by exchanging 45Y
for 40X reaches point E’ (which coincides with
E). Both nations gain from trade because they
consume on higher CIC II.
2.3.2 Trade between two countries whose factors
are different---general equilibrium analysis
U.S.
China
Steel
Steel
出口
PPF
0
0
30
50
Rice
40
60
Rice
 In isolation, China is in equilibrium at point
A. The rice’s price P0=0.5 in China is lower
than 1.5 in US. So China has a comparative
advantage in rice and US in wheat.
 With trade, China would specialize in the
production of rice incompletely, moving
from point A down to point S1 (60rice and
30wheat) because of increasing opportunity
costs. By then exchanging 20rice for
20wheat with US at P1=1, China ends up
consuming at point C1 (40rice and 50wheat)
on higher CIC1.
 The situations are the same in US. Therefore,
both China and US gain from specialization
and trade.
Partial Equilibrium Analysis
 We can derive Supply Curve, Demand Curve
and Domestic Equilibrium Price of one
commodity in both nations from PPF and CIC.
 With international trade, the commodity
price will be balanced on the condition that
the exports equal the imports or the supply
equals the demand.
 The total social welfare is determined by
consumer’s surplus(消费者剩余) and
producer’s surplus(生产者剩余). If there is
remains, international trade brings net
social welfare. Actually, free trade must
result in net welfare gain.
 Consumer surplus is the difference between
what consumers are willing to pay for a
specific amount of a commodity and what
they actually pay for it.
 Graphically, consumer surplus is measured
by the area under the demand curve above
the going price.
 Producer surplus is defined as a payment
that need not be made in the long run in
order to induce producers to supply a
specific amount of a commodity.
 Graphically, producer surplus is measured
by ?
Decision of the Price
China
P(K)
a
40
World
c
e
f
b
60 Rice
U.S.
20
30
d
50
§3 Factor - Price Equalization
and Income Distribution
3.1 The Factor-Price Equalization Theorem
 International trade will equalize the
relative and absolute returns to
homogeneous or identical factors across
nations. International trade acts as a
substitute(替代品) for the international
mobility of factors.
 So, international trade will cause the
prices of homogeneous labor and capital
to be the same in all trading nations, that
is, w and r will be the same in both
nations. This is true not only for relative
but also absolute or real wages and
interest rates.
Illustration of Factor Price
Equalization
 The horizontal axis measures w/r and the
vertical axis PX/PY.
 Before trade, Nation 1 is at point A, with
w/r =(w/r)1 and PX/PY =PA while Nation 2 is
at point A’, with w/r =(w/r)2 and PX/PY =PA’.
Since w/r is lower in Nation 1 than in Nation
2, PA is lower than PA’, Nation 1 has a
comparative advantage in X.
 With trade, Nation 1 specializes in the
production of commodity X and increases
the demand for labor relative to capital, w/r
rises. Nation 2 specializes in the production
of commodity Y and increases its relative
demand for capital, w/r falls. This will
continue until point B=B’, at which PB= PB’
and w/r =(w/r)* in both nations.
3.2 Effect of Intl Trade on the Short-run Distribution
of Income: Specific-Factors Model(特定要素模型)
3.2.1 The Price of Production Factors



From microeconomic theory, we know that
the value of the marginal product (边际产品价
值) of labor in the production of X is equal to
the price of commodity X times the marginal
physical product (边际产品) of labor in the
production of X.
That is, VMPLX=(PX)(MPLX). Similarly,
VMPLy=(Py)(MPLy).
Meanwhile, VMPKX=(PX)(MPKX);
VMPKy=(Py)(MPKy).
 Suppose that in Nation 1 (the L-abundant
nation) labor is mobile between industries
but capital is not. That is, some type of
capital could be used only or was specific to
the production of one good.
 Since labor is mobile, the wage of labor will
be the same in the production of
commodities X and Y in Nation 1.
 We also know that if a firm employs more
labor with a given amount of capital, VMPL
declines because of the law of diminishing
returns(报酬递减规律).
 Finally, to maximize profits, firms will
employ labor until the wage they must pay
equals the value of the marginal product of
labor (i.e., w=VMPL).
3.2.2 Specific-factors Model
 The model analyzes the effect of a change in
commodity price on the returns of factors in
a nation
when at least one factor is
W
W not
mobile between industries.
C
W2
E1
W1
W0
VMPLY
E0
VMPL’X
VMPLX
O’
O
L0
L1
 Labor is mobile between the two industries, but
capital is not. The horizontal axis measures the
total supply of L available to Nation 1, and the
vertical axis the wage rate.
 Before trade, the intersection of the VMPLX and
VMPLY curves determines w0 in the two
industries. OL0 of L is used in the production of X
and L0O’ in Y.
 With trade, PX/PY increases and shifts VMPLX up
to VMPL’X, w rises from w0 to w1, and L0L1 of L
shifts from Y to X.
 Since w rises less than PX, w falls in terms of X
but rises in terms of Y. With more L used with
fixed K in the production of X, VMPKX or r
increases in terms of X. With less L used with
fixed K in Y, VMPKY or r falls in terms of both
commodities.
 Suppose that labor was mobile, but capital
was not. Then, we have the specific-factors
model. The opening of trade leads to:
(1)an increase in the return or earning of
capital specific or used to produce the
nation’s export commodity;
(2)a reduction in the return or earning of
capital specific or used in the nation’s
import-competing(进口竞争性) industry;
(3)ambiguous(模糊的) results in the return or
earning of labor (the mobile factor).
The result for specific capital is clear.
 Since capital is specific to each industry, the
opening of trade does not lead to any
transfer of capital from the production of Y
to the production of X in the nation.
 Since the specific capital in the production
of commodity X has more labor to work with,
VMPKx and r increase in terms of both
commodities. With the opening of trade, the
real income of the capital rises in the
production of X.
 On the other hand, since less labor is used
with the fixed capital in the production of Y,
VMPKy and r fall in terms of both
commodities. With the opening of trade, the
real income of the capital falls in the
production of Y.
The effect of this on the real wage rate of labor
in the nation is ambiguous (not clear).
 The reason is that the increase in Px/Py and
in the derived demand for labor will be
greater than the increase in the nominal
wage rate, and so the real wage rate of
labor, w/Px, falls in terms of X.
 On the other hand, since the nominal wage
rate increased but the price of Y declined,
the real wage rate increased in terms of Y,
w/Py. Thus, the real wage rate in the nation
falls in terms of X but rises in terms of Y.
The effect on the real wage of labor is,
therefore, ambiguous.
3.3 Effect of Trade on the Long-run Distribution of
Income: Stolper-Samuelson Theorem
 Stolper-Samuelson Theorem postulates that
free international trade reduces the real
income of the nation’s relatively scarce and
expensive factor and increases the real
income of its relatively abundant and cheap
factor.
 It holds only if all factors are completely
mobile between the different industries or
sectors in each economy.
 In developed nations, labor is relatively
scarce and capital is relatively abundant,
int’l trade tends to reduce the real income of
labor and increase the real income of capital
owners. On the other hand, in less
developed nations, labor is relatively
abundant, international trade will increase
the real income of labor and reduce the
income of capital owners.
Shouldn’t the U.S. government restrict trade?
No. The loss that trade causes to labor is less than the
gain received by owners of capital.
CASE STUDY 4-2
 In real world, trade has not equalized the
earnings or returns to identical factors
across countries. Actually wages are much
higher for doctors, engineers, technicians,
mechanics, secretaries, and laborers in U.S.
and Germany than in Mexico and China.
 The reason is that many of the simplifying
assumptions on which the H-O theory rests
do not hold in the real world, and many
other forces (such as more rapid
technological change in some countries than
in others) also operate and tend to increase
international inequalities.
 However, wages have been certainly
equalized across industrial countries over
the past decades.
§4 Empirical Tests of the
Heckscher-Ohlin Theory
4.1 Leontief Paradox
Wassily Leontief
(1906-1999) ,1973
Nobel Prize in
economics. His most
significant one is
input-output
economics(投入-产出
经济学).
• Leontief expectations: to find United States
exported K-intensive commodities and
imported L-intensive commodities and prove
H-O model. He used the input-output table
to calculate the amount of labor and capital
in the exports and import substitutes(进口替
代产品) in U.S..
• The results: U.S. import substitutes were
about 30% more K-intensive than U.S.
exports. This is contrary to the H-O trade
model, which predicts that, as the most Kabundant nation, the United States should
import L-intensive products and export Kintensive products.
• import substitutes are commodities, such as
automobiles, that U.S. produces at home but
also imports from abroad.
1947 trade
Export
Import Substitutes
$2550,780
$3091,339
182
170
$14,010
$18,180
Export
Import Substitutes
$2256,800
$2303,400
Labor (manyears)
174
168
Capital/Labor
$12,977
$13,726
Capital
Labor (manyears)
Capital/Labor
1951 trade
Capital
4.2 Some Possible Explanations of
Leontief Paradox
 His First Explanation: In 1947, U.S. labor was
3 times as productive as foreign labor, so the
U.S. was L-abundant nation if we multiplied
the U.S. labor force by 3 and compared this
figure to the availability of capital in the nation.
Therefore, it exports L-intensive products. But
this is not reasonable.
 His Second Explanation (demand reversal 需求
逆转): U.S. consumers' tastes are so biased in
favor of K-intensive commodities that the
relative prices for these commodities were
very high. Therefore, their import substitutes
are more capital intensive. This is not
reasonable.
Other Explanations:
1. The year 1947 was too close to World War II to
be representative. (X)
2. Ignored human capital 人力资本(education, job
training, and health embodied in workers, which
increase their productivity). (√)
3. The U.S. dependence on imports of many
natural resources. (√)
4. Factor-intensity reversal 要素密集度逆转(a rather
rare occurrence) (X)
• A given commodity is the L-intensive commodity
in the L-abundant nation and the K-intensive
commodity in the K-abundant nation.
5. U.S. trade policy protected the L-intensive
industries. (X)
Key Terms
 Constant returns to scale
 Factor intensity, Factor abundance
 H-O theorem
 Factor-price equalization (H-O-S) theorem
 Specific-factors model
 Import substitutes
 Leontief paradox
 Human capital
 Factor-intensity reversal
calculation
Suppose that China is a small importer of
car. The supply of and demand for car are:
 Dc=2000-0.02P, Sc=1200+0.02P
 The world price is $10000. Please explain
the following questions with figures and
numbers:
(1) Before trade, the equilibrium production
and price in China;
(2) With free trade, the production and trade
volume of China;
(3) The welfare impacts of free trade on
consumers and producers and the whole
society.

Suppose both nations A and B apply the
same technology: producing 1 coat needs
1 capital and 3 labors; producing 1 food
needs 2 capitals and 2 labors. Nation A has
160 labors and 100 capitals; nation B has
120 labors and 80 capitals. Questions:
(1) Which nation is K-abundant?
(2) What commodity is L-intensive?
(3) If all resources are utilized at the most
efficient way, how many coats and foods
can be produced at most in both nations?
(4) If the tastes are the same in both nations,
which one will export coat? Which one will
export food?

Questions for Review
1. In what ways does the H-O theory
represent an extension of the trade model
presented in the previous chapters? What
did classical economists say on these
matters?
2. State the assumptions of the H-O theory.
What is the meaning and importance of
each of these assumptions?
3. What is meant by labor-intensive
commodity? Capital-intensive commodity?
Capital-labor ratio?
4. What is meant by capital-abundant nation?
What determines the shape of the
production frontier of each nation?
5. What determines the capital-labor ratio in
the production of each commodity in both
nations? Which of the two nations would
you expect to use a higher capital-labor
ratio in the production of both commodities?
Why? Under what circumstance would the
capital-labor ratio be the same in the
production of both commodities in each
nation?
6. If labor and capital can be substituted for
each other in the production of both
commodities, when can we say that one
commodity is capital intensive and the other
labor intensive?
7. What does the H-O theory postulate? Which
force do Heckscher and Ohlin identify as the
basic determinant of comparative advantage
and trade?
8. What does the factor-price equalization
theorem postulate? What is its relationship
to the international mobility of factors of
production?
9. Explain why the H-O theory is a general
equilibrium model.
10. What is meant by the Leontief paradox?
What are some possible explanations of the
paradox? How can human capital contribute
to the explanation of the paradox?
11. What were the results of empirical tests
on the relationship between human capital
and international trade? Natural resources
and international trade? What is the status
of the H-O theory today?
12. What is meant by factor-intensive reversal?
Why would the prevalence of factor reversal
lead to rejection of the H-O theorem and the
factor-price equalization theorem? What
were the results of empirical tests on the
prevalence of factor reversal in the real
world?
Problems
1.Starting with the production frontiers for
Nation 1 and Nation 2 shown in the figure
“The H-O Model”, show graphically that
sufficiently different tastes in the two
nations could conceivably neutralize the
difference in their factor endowments and
lead to equal relative commodity prices in
the two nations in the absence of trade.
2. Draw a figure similar to the figure “The H-O
Model” but showing that the H-O model
holds, even with some difference in tastes
between Nation 1 and Nation 2.