The document discusses the Heckscher-Ohlin model of international trade. The model assumes two countries, two goods, and two factors of production (labor and capital). It predicts that the labor-abundant country will export the labor-intensive good, while the capital-abundant country will export the capital-intensive good. This is known as the Heckscher-Ohlin theorem. The model aims to explain trade patterns between countries based on differences in their relative factor endowments.

1. Heckscher–Ohlin model
Meeting 2

2. Two Factor Heckscher-Ohlin Model
1. Two countries: home and foreign.
2. Two goods: cloth and food.
3. Two factors of production: labor and capital.
4. Production of food is land-intensive and production of cloth is
labour-intensive in both countries.
5. Perfect competition prevails in all markets.

3. 2×2×2 model
• The original H–O model assumed that the only difference between
countries was the relative abundances of labour and capital.
• The original Heckscher–Ohlin model contained two countries, and
had two commodities that could be produced. Since there are two
factors of production this model is sometimes called the "2×2×2
model"

4. The Heckscher-Ohlin Theorem
• Note that when trade occurs, the labor-abundant country (Home)
exports the labor-intensive good (cloth) and
• The land-abundant country (Foreign) exports the land-intensive good
(food)
• In general, each country exports the good that makes intensive use
of the resource that is abundant in that country
• This is called the Heckscher-Ohlin Theorem

5. • The H-O model assumes that the only difference between countries
are these variations in the relative endowments of factors of
production.

6. Slide 4-6 Copyright © 2003 Pearson Education, Inc.
• In the real world, while trade is partly explained by
differences in labor productivity, it also reflects
differences in countries’ resources.
• The Heckscher-Ohlin theory:
• Emphasizes resource differences as the only source of
trade
• Shows that comparative advantage is influenced by:
• Relative factor abundance (refers to countries)
• Relative factor intensity (refers to goods)
• Is also referred to as the factor-proportions theory

7. Factor abundance

8. Factor intensity

9. The Heckscher-Ohlin Theorem
• The H-O theorem predicts the pattern of trade between countries
based on the characteristics of the countries.
• The H-O theorem says that a capital-abundant country will export the
capital-intensive good
• While the labour-abundant country will export the labour-intensive
good.

10. The contribution of Heckscher-Ohlin theory
• The theory’s main contribution is to point out that cross-
country differences in relative resource availability can
explain trade
• It does not claim that differences in relative resource
availability are the only reason why trade occurs

11. Good 1
Good2
Country I
Country II

12. - Customers in both countries have similar tastes
- If the tastes are too similar, the indifference curve I works for both
countries (the same level of utility)
- The indifference curve will touch the production capacity curve of a
country I in point A and for country II in point A’
representing the maximum possible volumes of production and
consumption of each country in the absence of trade,
- The tangent lines determine the relative prices P and P' for good 1 and
2 in countries I and II
- Since, as can be seen from the graph, P <P ', country I has a relative
advantage in the production of good 1, and country II - in the production
of good 2.
Country I Country II
Is producing Good 1 Is producing Good 2
Is exporting Good 1 Is exporting Good 2
Labour abundant Capital abundant

13. Good 1
Good2 Country I
Country II

14. • The points showing the volumes of production and consumption are shifted from A to B for
country I and from A 'to B' for country II.
• Specialization will continue until countries reach the level of the total equivalent relative world
price Pw that, as it was established above, will be located somewhere between the internal
relative prices of each country before the commencement of trade, that is, P <Pw <P’
• The new indifference curve II is much higher than the indifference curve I, which indicates a
general increase in consumption.
• Country I, exporting BC of good 1 and importing CE good 2 produced in country II, achieves a
balance of demand and supply at the point E.
• Country II, exporting B'C' of good 2 and importing C'E'of good 1 from country I, provides a balance
of supply and demand at the point E ', which coincides with the point E.
• As can be seen, the export of goods 1 by country I equals its import by country II BC = C'E'
• And the export of goods 2 by country II equals its import by country I (B'C '= CE).

15. The Heckscher-Ohlin Assumptions—Markets
• All markets are perfectly competitive.
• That is, no buyer or seller of a commodity has the power to affect the price of
the commodity by himself. More specifically, the market for a commodity is
said to be perfectly competitive if:
• There are many sellers
• There are many buyers
• All sellers sell the exact same product
• Individuals make decisions so as to maximize happiness, whereas
• Firms make decisions so as to maximize profits

16. The Heckscher-Ohlin Assumptions—Governments
• Governments do not interfere with the smooth functioning of
markets; there are no taxes, subsidies, tariffs, quotas, etc.
• However, although there is free trade in goods and services, there is
no cross-border movement of resources, such as labor

17. The Heckscher-Ohlin Assumptions—Technology
• Technological knowledge is the same in both countries
• Goods are produced (with land and labor) using technologies that
satisfy Constant Returns to Scale.
• That is, if the producer of a commodity, say, doubles the amounts used of all
resources, then the amount produced will have to double also.

18. The Heckscher-Ohlin Assumptions—Factor
Abundance
• Home has a higher ratio of labor to land than Foreign does.
• That is, if TH, TF, LH, and LF denote the amounts of T (land or territory) and L
(labor) that Home and Foreign are endowed with, then LH / TH > LF/ TF. L/T
may be informally interpreted as the number of workers per acre of land.
• Home is said to be the “labor-abundant” country and Foreign is the “land-
abundant” country.

19. The Heckscher-Ohlin Assumptions—Factor
Intensities
• The production of food is land-intensive and the production of cloth is
labor-intensive
• That is, the number of workers per acre (L/T) is always higher in cloth
production than in food production