The H-O Theorem with Physical Definition of Factor Abundance

1. Modern theory of trade: H-O Theorem
(Physical abundance)

2. Introduction
• As per neoclassical theory difference in autarkic price ratio is the
basis of trade between two countries
• H-O theory tried to make an inquiry about the factors responsible for
such difference
• As per H-O theory factor abundance and factor intensity are the
major determinants of the pattern of trade

3. Assumptions
• It’s a 2X2X2 Model
• Factors are perfectly mobile within the country but can’t migrate
internationally
• Perfect competition
• 𝑥 = 𝑓 𝑙, 𝑘 and 𝑦 = 𝑔 𝑙, 𝑘 in both countries
• Countries can be ranked according to factor abundance
• Commodities can be ranked unambiguously as per factor intensity
• Production functions are subject to CES and CRS
• Free trade

4. Factor Abundance and Factor Intensity
• Leontief Definition:-
Country A is relatively labour abundant and Country B is relatively capital abundant if
𝐿𝑎𝑏𝑜𝑢𝑟 𝑒𝑛𝑑𝑜𝑤𝑚𝑒𝑛𝑡 𝑖𝑛 𝐴
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑛𝑑𝑜𝑤𝑚𝑒𝑛𝑡 𝑖𝑛 𝐴
>
𝐿𝑎𝑏𝑜𝑢𝑟 𝑒𝑛𝑑𝑜𝑤𝑚𝑒𝑛𝑡 𝑖𝑛 𝐵
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑛𝑑𝑜𝑤𝑚𝑒𝑛𝑡 𝑖𝑛 𝐵
Ohlin Definition
Country A is relatively labour abundant and Country B is relatively capital abundant if
𝑤
𝑟
𝐴 <
𝑤
𝑟
𝐵
Factor intensity
Commodity X is relatively labour intensive if
𝑎 𝐿𝑋
𝑎 𝐾𝑋
>
𝑎 𝐿𝑌
𝑎 𝐾𝑌
; 𝑎𝑖𝑗= amount of factor 𝑖 required to produce 1 unit of commodity 𝑗
𝑖 = 𝐿, 𝐾. 𝑗 = 𝑋, 𝑌

5. Proposition of H-O Theorem
• Relatively labour abundant country will enjoy comparative advantage
in relatively labour intensive commodity and vice versa

6. H-O Theorem on Leontief’s Definition
• Identical taste and preference for the sake of simplicity
• Country B is relatively capital abundant and vice versa.
• B would definitely have a production bias towards Y and vice
versa
• AA and BB are PPC s of two countries
• Same preference pattern=> Same Community Indifference map
• E and F are the autarkic equilibria of A and B respectively
• Slope of p= Autarkic price ratio of B
• Slope of p*= Autarkic price ratio of A
• Autarkic price ratio of X and Y is more in B
• A (relatively labour abundant) enjoys comparative advantage in X
(relatively capital intensive) and vice versa