Hecksher Ohlin theory, Factor endowments theory, Modern Theory of International Trade, 2*2 theory, factor proportions theory, H-O Model, theory of International Trade

1. The
Heckscher – Ohlin
Theory
Seminar by ,
CLINCY
CLEETUS
S2. M.COM.
ROLL:NO:10
DEPT OF
COMMERCE
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2. OVERVIEW
• Other names.
• Factor endowments.
• Heckscher – Ohlin theory.
• Assumptions.
• Limitations.
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3. Other names
• Modern theory of international trad
• H-O theory/ theorem.
• Factor proportions theory.
• Factor endowments theory.
• Relative factor endowments theory.
• H-O model.
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4. Factor endowments
• Land
• Labour
• Capital
• Natural resources
• Climate etc…
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5. Assumptions of Heckscher Ohlin's H-O Theory
Heckscher-Ohlin'stheory explainsthe modern approach to
internationaltrade on the basis of following assumptions :-
• Thereare two countries involved.
• Each country has two factors (labour and capital).
• Each countryproduce two commodities or goods (labour intensive and
capital intensive).
• Thereis perfect competition in bothcommodity and factor markets.
• All production functions are homogeneous of the first degreei.e.
production function is subject to constant returns toscale.
• Factors are freely mobile within a country but immobile between
countries.
• Twocountries differ in factor supply. 5

6. • Each commodity differs in factor intensity.
• The production function remains the same in different countries for the
same commodity. Fore.g. If commodity A requiresmore capital in one
countrythensameis the casein other country.
• Thereis full employment of resourcesin both countries and demand are
identical in both countries.
• Trade is free i.e. there are notrade restrictions in theform of tariffs or
non-tariff barriers.
• Thereare no transportation costs.
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7. Heckscher – Ohlin theory
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8. • The theory explains in a two country, two
factor and two commodity (
2*2*2 model ) framework.
1. what determines the comparative advantage ?
2. How trade influence the income of the factors of
production ?
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9. • The theory believes that differentcountries are endowed with
varying proportions of different factors of production.
• Some countries have large population and large labour resource.
The others have abundance of capital but short of labour
resource.
• Capital abundant country presents a higher capital ratio than
whata labourabundant countypresents.
• Thus, a country withlarge labour forcewillbe able to produce
those goods at lowercost that involve labour intensivemode of
production.
• Similarlythe countries withlarge supply of capital will specialize
in those goods that involvecapital intensivemode of
production. 9

10. • The former will exportits labourintensive goods to the latter
and import capital intensive goods there from.
• After the trade, both the countries willhaveboth types of goods
at the least cost.
• Allthis means that the theoryholds good if the capitalabundant
country has a distinct preference for the labour intensivegoods
andthe labour abundant countryhas a distinctpreference for
capital intensive goods. Ifit is not, the theory may not hold
good.
• Again the theory does not hold good if the labour abundant
country is technologicallyadvancedin capital intensivegoods or
if capitalabundant economy is technologicallyadvancedinthe
production of labour intensive goods. 10

11. Limitations of H-O
Theory
• UnrealisticAssumptions
• Restrictive
• One-sided theory
• Static in nature
• Wijnhold’s criticism
• Consumer’s demand ignored
• Haberler’s criticism
• Leontif paradox
• Other factors neglected 11

12. 1. Unrealistic Assumptions
• Besides the usual assumptions of two countries,
two commodities, no transport cost, etc.
• Ohlin's theory also assumes no qualitative
difference in factors of production, identical
production function, constant return to scale,
etc.
• All these assumptions makes the theory
unrealistic one.
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13. 2. Restrictive
• Ohlin's theory is not free from
constrains.
• His theory includes only two
commodities, two countries and two
factors.
• Thus it is a restrictive one.
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14. 3. One-Sided Theory
• According to Ohlin's theory, supply plays a
significant role than demand in determining
factor prices.
• But if demand forces are more significant, a
capital abundant country will export labour
intensive good as the price of capital will be
high due to high demand for capital.
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15. 4. Static in Nature
• Like Ricardian Theory the H-O Model is
also static in nature.
• The theory is based on a given state of
economy and with a given production
function and does not accept any
change.
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16. 5. Wijnholds's Criticism: According to Wijnholds, it is not
the factor prices that determine the costs and commodity
prices but it is commodity prices that determine the factor
prices.
6. Consumers' Demand ignored: Ohlin forgot an important
fact that commodity prices are also influenced by the
consumers' demand.
7. Haberler's Criticism: According to Haberler, Ohlin's
theory is based on partial equilibrium. It fails to give a
complete, comprehensive and general equilibrium analysis.
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17. 8. Leontief Paradox: American economist Dr. Wassily Leontief
tested H-O theory under U.S.A conditions.
He found out that U.S.A exports labour intensive goods and
imports capital intensive goods, but U.S.A being a capital
abundant country must export capital intensive goods and
import labour intensive goods than to produce them at home.
This situation is called Leontief Paradox which negates H-O
Theory.
9. Other Factors Neglected: Factor endowment is not the sole
factor influencing commodity price and international trade.
The H-O Theory neglects other factors like technology,
technique of production, natural factors, different qualities of
labour, etc., which can also influence the international trade.
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