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Chapter 4
The HeckscherOhlin Model
Topics to be Covered
• The Heckscher-Ohlin (HO) Model: Basic
Assumptions
• The HO Theorem
• Equilibrium in the HO model
• Some New HO Theorems
• Some Final Observations
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Heckscher-Ohlin (HO) Model
•
Developed by Eli Heckscher and Bertil
Ohlin, Swedish economists.
•
Model based on two concepts:
1. Factor endowments—the quantities of
productive resources possessed by a country
2. Factor intensity—the amount of labor per unit
of capital used in production of a product
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Assumptions of HO Model
• Keep first 10 assumptions (from chapters 2
and 3)
• Drop assumptions 11 (labor is only
resource) and 12 (constant returns to scale)
• Add five new assumptions
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Five New Assumptions
• Assumption 13—Two resources, labor (L)
and capital (K), and resource payments,
wages for labor (W) and rent for capital (R)
• Assumption 14—Identical technology in
both countries; choice of production
technique depends on factor prices
(Note: this assumption rules out the
classical basis for international trade)
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Assumption 15
• Assumption 15—Production of good T is
more labor-intensive than that of good S.
Production of both goods in both countries is
subject to constant returns to scale.
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Assumption 15 (cont.)
• Labor (capital)-intensive—a good is labor
(capital)-intensive relative to another if its
production requires more (less) labor per
machine than the other good requires in its
production.
• Mathematically, assumption 15 requires:
LT / K T  LS / K S
where Lj is labor employed in jth industry
(j=S or T) and Kj is capital employed in jth
industry. See Global Insights 4.1 for examples.
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Assumption 16
• Assumption 16—Country A is relatively
capital-abundant while B is relatively laborabundant.
• Two definitions of resource abundance:
– Quantity definition
– Price definition
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Capital Abundance:
Quantity Definition
• Country A is relatively capital-abundant if:
KA/LA > KB/LB
where Kn is capital endowment in
country n (n=A or B) and Ln is labor
endowment in country n.
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Capital Abundance:
Price Definition
• Country A is relatively capital-abundant if:
RA/WA < RB/WB
where Rn is rental payment in country n
(n = A or B) and Wn is the wage rate in
country n.
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Production Possibility
Frontier
• Since the two goods differ in factor intensity
in both countries, the PPFs of each country
will exhibit increasing opportunity cost (i.e.,
PPF will have a bowed out, nonlinear
shape).
• Because country B is labor-abundant and
good T is labor-intensive, B’s PPF will lie
primarily along (or biased toward) the Taxis (see Figure 4.1).
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FIGURE 4.1 Country B’s Production
Possibility Frontier
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Assumption 17
• Tastes in the two countries are identical.
That is, both countries have the same set of
community indifference curves (CIC).
• This assumption guarantees that a country’s
comparative advantage is determined
primarily by supply, not demand, factors.
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Heckscher-Ohlin Theorem
• A country will have comparative advantage
in, and therefore will export, that good
whose production is relatively intensive in
the factor with which the country is
relatively well-endowed.
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Graphical Proof of HO
Theorem
• Given different PPFs for the two countries
and identical CICs, find autarky equilibrium
points for both countries (see Figure 4.2)
• At the equilibrium point, the slope of each
country’s PPF equals the pre-trade price
ratio
• Since (PS /PT )A < (PS /PT )B , then A(B) has
comparative advantage in, and will export,
good S(T)
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FIGURE 4.2 Proof of the HO
Theorem
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Effect of Rising World Price of
Good S on Country A’s Trade
• Refer to Figure 4.3
• Once trade begins, the price of S will rise (as
represented by the three terms of trade or price lines)
• As the price rises from (PS/PT)0 to (PS/PT)1 , A’s
production point moves from X0 to X1.
• With trade, A’s new consumption point is now C1.
• A’s trade triangle is V1C1X1 where V1X1 represents A’s
exports and V1C1 is A’s desired imports.
• The terms of trade that will prevail once trade begins
are determined by reciprocal demand.
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FIGURE 4.3 The Effect of Rising World
Prices of Good on Country A’s Trade
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Trade Equilibrium in HO Model
• Refer to Figure 4.4
• Terms of trade are determined by reciprocal
demand and lie between the two countries’
pre-trade price ratios
• Equilibrium production with trade exhibits
incomplete specialization (due to increasing
opportunity cost)
• Equilibrium consumption with trade implies
a rise in standard of living
• Trade triangles are congruent
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FIGURE 4.4 Trade Equilibrium in
the HO Model
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Differences between Classical
and HO Models
• Complete specialization results in classical model,
while incomplete specialization occurs in HO
model.
• In classical model, only demand conditions affect
reciprocal demand. In HO model, reciprocal
demand leads to equilibrium price via changes in
both demand and supply.
• Autarky price in the classical model is determined
only by supply conditions. In HO model, demand
and supply determine autarky price.
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Reciprocal Demand in the
Classical and HO Models
• Refer to Figure 4.5
• The national supply curves differ in the two models.
In the classical model, the national supply curve is
horizontal (due to constant cost) up to the point of
complete specialization, at which the curve becomes
vertical. In the HO model, the curve is initially
upward-sloping (due to increasing costs).
• Autarky equilibrium is achieved where the national
demand and national supply curves intersect. Since
the relative price PS/PT is lower in country A, then A
has a comparative advantage in good S.
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FIGURE 4.5 Reciprocal Demand in
the Classical and HO Models
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Reciprocal Demand
(Classical Model)
• See Figures 4.5a and 4.5b.
• When trade begins at a world price p0, A’s
production of S rises to its complete
specialization level and A exports what it
does not consume. In country B, production
of S falls to zero and its imports of S
increase.
• Due to excess demand at p0, the world price
will rise and consumption in both countries
will fall until the world markets attain
equilibrium at new world price p1.
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Reciprocal Demand (HO Model)
• See Figures 4.5c and 4.5d
• Similar to the Classical model except in how
the excess demand is eliminated. As the
world price rises in response to the excess
demand, consumption falls in both countries
but supply also rises in both countries.
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The Importance of Assuming
Identical Tastes in the HO Model
• See Figure 4.6
• Initially, country A has a comparative advantage in
good S due to lower autarky relative price and a
lower supply curve (indicating natural comparative
advantage).
• Suppose that national tastes are different in that A’s
citizens strongly prefer good S while B’s citizens do
not.
• As a result, A’s demand curve shifts upward while
B’s demand shifts to the left.
• Relative prices change such that B now has the
comparative advantage in good S.
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FIGURE 4.6 The Importance of
Assuming Identical Tastes
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Some New HO Theorems
• Rybczynski Theorem
• Factor Price Equalization Theorem
• Stolper-Samuelson Theorem
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Rybczynski Theorem
• At constant world prices, if a country
experiences an increase in the supply of one
factor, it will produce more of the product
intensive in that factor and less of the
other.
• See Figure 4.7
• Countries with high savings and investment
rates will tend to produce and trade more
capital-intensive goods.
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FIGURE 4.7 The Effect of an
Increase in A’s Capital Stock
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Factor Price Equalization
Theorem
• Given all the assumptions of the HO model,
free international trade will lead to the
international equalization of individual factor
prices.
• Country A is relatively capital-abundant and
rent is low. With trade, the increase in
demand for capital for producing exports
raises rent. The opposite happens in country
B.
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Stolper-Samuelson Theorem
• Free international trade benefits the
abundant factor and harms the scarce
factor.
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Implications of StolperSamuelson Theorem
• Some groups in society will oppose
international trade.
• Scarce factors will lobby government for
trade protection.
• Even though some in society lose, the
country overall benefits from international
trade relative to autarky.
• A system of taxation and transfers could
be developed to compensate the losers
while leaving the gainers better off relative
to autarky. See Global Insights 4.2.
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