The factor endowment theory of international trade was developed by Swedish economists Eli Heckscher and Bertil Ohlin. Ohlin built upon Heckscher's work and published his theory in his 1933 book. The theory explains that countries will export goods that intensively use their abundant factors and import goods that intensively use their scarce factors. It assumes two countries, two goods, and two factors of production. A country is said to be factor abundant based on either having a higher capital to labor ratio or lower relative price of that factor. The theory shows graphically how trade leads to specialization according to comparative advantage. It makes restrictive assumptions about production functions and consumer preferences that limit its realism.

1. B.COM SEM-V
UNIT-I
International Economics

2. Eli Heckscher
(1879- 1952) (1899–1979)

3. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: ORIGIN
• The theory was developed by the Swedish economist Bertin Ohlin (1899–
1979) on the basis of work by his teacher the Swedish economist Eli Fillip
Heckscher (1879–1952). For his work on the theory, Ohlin was awarded
the Nobel Prize for Economics in 1977.
• Bertin Ohlin developed a new theory of international trade in 1933, in his
famous book “Interregional and international trade", criticizing the classical
theories of international trade.
• This theory was given by Bertin Ohlin on the basis of his teacher Eli Fillip
Heckscher's article “Pattern of international trade" published in 1919.
• This theory is also known as modern theory of international trade, factor
endowment theory, factor proportion theory of international trade, and 2x2x2
model of international trade.

4. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: ASSUMPTIONS
• There are two countries and two commodities and two
factors of production.
• There are quantitative differences in factor endowments in
different regions, but qualitatively they are homogenous.
• Production functions of the two commodities have different
factor intensities, that is labour intensive and capital
intensive.
• Production functions are different for different commodities
but are same for each commodity in both countries.
• There is perfect mobility of factors within each region but
internationally they are immobile.
• There are constant returns to scale in the production of each
commodity in each region.

5. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: ASSUMPTIONS
• Preference of consumers and their demand pattern
are identical in both countries.
• There is no change in technical knowledge.
• There is perfect competition in commodity market
and factor markets both.
• There is full employment of resources.
• There is no cost of transportation between the
countries
• Trade between two countries is free and
unrestricted.

6. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: EXPLANATIONS
• Heckscher-Ohlin theory, in economics, a theory
of comparative advantage in international trade according to
which countries in which capital is relatively plentiful and
labour relatively scarce will tend to export capital-intensive
products and import labour-intensive products, while countries
in which labour is relatively plentiful and capital relatively
scarce will tend to export labour-intensive products and import
capital-intensive products.
• Thus here Prof. Ohlin is focused on factor proportions and
explains his theory on the basis of these two criteria, Physical
criterion and price criterion.

7. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: EXPLANATIONS
• Physical criterion:-
• According to physical criterion, a country is said to be relatively
capital abundant if it is endowed with a high proportion of capital to
labour than in the other country. In other words ,a country is capital
rich if the following conditions holds:
• KA > KB
LA LB
• KA = Capital in Country A
• LA = Labour in Country A
• KB = Capital in Country B
• LB = Labour in Country B

8. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: EXPLANATIONS
• Price criterion:-
• According to physical criterion, a country having capital relatively
cheap and labour relatively dear is capital abundant country
irrespective of the ratio of the quantity of capital to quantity of
labour compared with other country: country A will now be capital
rich compared with country B if,
• (PK) < (PK )
(PL) (PL)
• PK = Price of Capital
• PL = Price of Labour
• (PK) = (PK ) Trade is not possible
(PL)A (PL)B

9. FACTOR
ENDOWMENT
THEORY
OF
INTERNATIONAL
TRADE

10. Y
Y
X
X
E
D H N R B2
A
B
A’ B’
C
K
M
T
G
L
S
Labour
Capital
B1
O X
Y

11. FACTOR ENDOWMENT THEORY OF
INTERNATIONAL TRADE: LIMITATIONS
• Assumption of 2x2x2 is not possible.
• Wrong assumption of preference of consumers and their
demand pattern are identical in both countries.
• Ignore role of product differentiation
• Given more importance to supply of factors of production
• Homogeneous factors of production
• Identical production function
• Transportation cost
• There is no change in technical knowledge.
• There is full employment of resources.
• Trade between two countries is free and unrestricted.