1) The document discusses the Heckscher-Ohlin theory of international trade, which predicts patterns of trade based on the relative abundance of factors of production like capital and labor across countries. 2) It outlines the key assumptions of the theory, including that countries have different endowments of factors and production of goods uses these factors with different intensities. 3) The theory suggests that a capital-abundant country like the US will produce and export capital-intensive goods like cars, while a labor-abundant country like India will produce and export labor-intensive goods like cotton clothes.

1. Factor Endowments and the
Heckscher-Ohlin Theory
By: Dr. Neelam Tandon

2. Assumptions of the Theory
A. The Assumptions
1) There are two nations (India &USA), two
commodities (Cotton Clothes& Car), two factors of
production (labor & capital).
 Used to illustrate the theory in a two-dimensional figure.
2) Both nations use the same technology in production.
 Means both nations have access to and use the same
general production techniques.

3. 3) Commodity cotton clothes is labor
intensive and Car is capital intensive in
both nations.
 Means the labor-capital ratio (L/K) is higher
for cotton clothes than car in both nations at
the same relative factor prices.

4. 4) Both commodities are produced under constant
returns to scale in both nations.
 Means that increasing the amount of L and K will
increase output in the same proportion
5) There is incomplete specialization in production in
both nations.
 Means that even with free trade both nations continue
to produce both commodities. This implies neither
nation is very small.

5. 6) Tastes are equal in both nations.
 Means demand preferences are identical in
both nations. When relative prices are equal
in the two nations, both consume cotton
clothes &car in the same proportion.

6. 7) There is perfect competition in both commodities
and factor markets in both nations.
 Means that producers, consumers, and traders of
cotton clothes &cars in both nations are each too
small to affect prices of commodities. Also, in the L-
R commodity prices equal their costs, leaving no
economic profit.

7. 8) There is perfect factor mobility within
each nation but no international factor
mobility.
 Means K&L are free to move from areas and
industries of lower earnings to those of higher
earnings until earnings are the same in all
areas, uses and industries of the nation.
International differences in earnings persist
due to zero international factor mobility in
the absence of international trade.

8. 9) There are no transportation costs, tariffs, or other
obstructions to the free flow of international trade.
 Means specialization in production proceeds until
relative (and absolute) commodity prices are the same
in both nations with trade. If transportation costs and
tariffs were allowed, specialization would proceed only
until prices differed by no more than the costs and
tariffs on each until of the commodity traded.

9. 10) All resources are fully employed in both nations.
 Means there are no unemployed resources in either
nation.
11)International trade between the two nations is
balanced.
 Means that the total value of each nation’s exports
equals the total value of the nation’s imports.

10. TABLE Capital per Worker Endowments of Selected Countries in 1990
________________________________________________________________________________
Country k/L ($000) Country K/L ($000) Country K/L ($000)
Argentina 8 Greece 24 Norway 60
Australia 58 Guatemala 4 Panama 9
Austria 48 India 3 Philippines 5
Belgium 52 Ireland 37 Portugal 19
Bolivia 3 Israel 32 South Africa 12
Brazil 14 Italy 50 Spain 46
Canada 66 Japan 56 Sri Lanka 5
Chile 18 Jordan 13 Sweden 49
Colombia 10 Kenya 1 Thailand 9
Costa Rica 10 Korea 32 Turkey 13
Denmark 43 Malaysia 23 UK 39
Ecuador 13 Mauritus 7 Uruguay 10
Finland 64 Mexico 18 USA 63
France 57 Netherlands 50 Venezuela 19
Germany 54 New Zealand 46 Zimbabwe 2
_________________________________________________________________________________
Source: Peter K. Schott, “One Size Fits All? Heckscher-Ohlin Specialization in Global Production,”
American Economic Review, June 2003, pp. 686-708.

11. Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier (PF)
A. Factor Intensity
 In a world of 2 commodities and 2 factors, car is
capital intensive if its (K/L) is greater than (K/L) of
cotton clothes .
 If production of Car requires 2K and 2L, then
K/L=1.

12.  If production of Cotton clothes requires 1K
and 4L, then K/L=1/4.
 We say that car is K intensive and cotton
clothes is L intensive.
 Measuring K and L intensity depends on K/L
rather than the absolute amount of K and L.

13. FIGURE 5-1 Factor Intensities for Commodities X (cotton
clothes)and Y(Car)
in Nations 1 (India) and 2(USA).

14.  India can produce 1cotton clothe using 1K-4L, and
2cotton clothes using 2K-8L. Thus, K/L=1/4, this gives
the slope of the ray of cotton clothes in India.
 In Nation USA , K/L=4 for Car and 1 for cotton clothe.
 Therefore, Car is the K-intensive commodity, and
cotton clothe is the L-intensive in USA also. This is
shown by the fact that the ray from the origin for good
Car is steeper than that of cotton clothes in both nations.
 Even though car is K-intensive relative to cotton
clothes in both nations, USA uses a higher K/L than
India .
 For Car , K/L=4 in USA but K/L=1 in India.
 For cotton clothe, K/L=1 in USA but K/L=1/4 in India.

15.  Q: Why does Nation 2 (USA) use more K-intensive
production techniques in both commodities than Nation
1(India)?
 A: 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.

16.  Q: But why is capital relatively cheaper in Nation 2?
 A: We must define factor abundance and examine its
relationship to factor prices.
 If the price of capital falls, producers would substitute
capital for labor in production of X&Y to minimize
production costs. As a result, both commodities
become K-intensive. If K/L of Y (car) exceeds K/L
of X(cotton clothe), Y is considered a K-intensive
commodity.

17. B. Factor Abundance
 Two ways to define factor abundance:
1) In terms of physical units (i.e. overall amount of
K&L (TK/TL) available to each nation).
 According to this definition, Nation 2 is capital
abundant if the ratio of total amount of capital to total
amount of labor available in Nation 2 is greater than
that in Nation 1.
 The ratio of TK/TL what is important , not the
absolute amount of K&L available in each nation.
 Thus, Nation 2 can have less K than Nation 1 and still
be the capital abundant nation if TK/TL in Nation 2
exceeds TK/TL in Nation 1.

18. 2) In terms of relative factor prices (i.e. rental price of K
(PK) and the price of L time (PL) in each nation).
 According to this definition, Nation 2 is K abundant if
(PK/PL) is lower in Nation 2 than in Nation 1.
 Since rental price of K is taken to be the interest rate (r)
and the price of labor time is wage (w), then PK/PL= r/w.
 The ratio r/w what is important , not the absolute level of
r that determines whether a nation is K abundant.
 The first definition considers only the supply of factors,
while the second definition considers both demand and
supply.
 The demand of the factor is derived from demand for the
final commodity that requires the factor in its production.

19. C. Factor Abundance and the Shape of the
Production Frontier
 Since Nation 2 is K-abundant and Y is K-intensive,
Nation 2 can produce relatively more of Y than
Nation 1.
 Since Nation 1 is L-abundant and X is L-intensive,
Nation 1 can produce relatively more of X than
Nation 2.
 This gives a production frontier for Nation 1 that is
relatively flatter and wider that that of Nation 2.

20. FIGURE 5-2 The Shape of the Production Frontiers of
Nation 1 and Nation 2.