Heckscher-Ohlin model

1
Heckscher-Ohlin model

• Eco 3024F
• Readings
• Ch5 Factor endowments and HO theory. Salvatore,
  D. (in reader)

2
Reasons for Trade

• Why are countries different?
• Production (supply)
• 1) Technology (production functions) (RICARDO),
• 2) factor endowments (Land, Labour, Capital)
• 3) returns to scale
• 4) competitive conditions,
• 5) governments taxes subsidies
• Consumption (Demand)
• Community indifference Curve (CIC) (tastes
  preferences)
• Any difference in production will lead to
  different price ratios in closed economnies.
  Different relative prices result in trade.

3
GE framework of HO model in closed economy
Commodity prices
4
Ricardo model

• Why are countries different?
• Different Technology ? different relative prices
• What are the limitations of model?
• Model assumes full specialization
• What are the sources of labour productivity?
  Capital?
• Income distribution Model predicts that all
  factors gain
• Cannot explain intra-industry trade
• What about other factors of production?

5
Heckscher-Ohlin

• Why are countries different?
• 2) Different factor endowments
• SA exports resource intensive products (iron
  steel, gold, uranium) because of its resource
  endowments, not because of differences in
  relative labour productivity

6
The composition of regional trade

• Why does the composition of Zim-US trade with
  each other differ?

7
Resource (factor) endowments

• Capital and labour endowments
• Country capital stock (b) labour force(m) K/L
• India 482 254 1,9
• Brazil 507 53 9,5
• Mexico 353 23 15,3
• US 3 696 116 32,4
• Germany 1 018 26 39,1
• Switzerland 120 3 40

8
Resource (factor) intensities

• Capital and labour ratios in selected U.S.
  industries
• Industry capital (b) labour (m) K/L(th)
• Petroleum 27 .09 284
• Iron Steel 25 .505 50
• Footwear .514 .107 4.8
• Clothing 3.4 .978 3.5

9
Where are we going?

• What will we show?
• Trade patterns determined by the countrys
  relative abundance of resources (factors) and the
  relative intensity in which these resources
  (factors) are used in production
• How will we show it?
• Differences in relative resource endowments cause
  differences in relative prices

10
Assumptions of H-O

• HO only works if we make the following
  assumptions
• 2 nations (US SA), 2 goods (Shoes Cars) and 2
  factors (capital K labour L)
• Factors immobile internationally, perfectly
  mobile nationally
• Same production technology in both countries
• Constant returns to scale
• Identical preferences
• Perfect competition in all markets
• Zero transport costs or trade barriers, full
  utilization of resources in both countries trade
  balance is zero

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H-O model

• Assume
• Car production is capital intensive (K/L)c
• Shoe production is labour intensive (K/L)Sh
• (K/L)c gt (K/L)Sh
• kc gt kSh
• 2) US is capital abundant
• SA is labour abundant
• (Kstock/Lstock)US gt (Kstock/Lstock)SA

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Producer Optimization (GE)
Perfect competition and mobile factors implyw/r
is same for shoe and car industry
Producer equilibriumMRTSC MPLC/MPKC w/r
MRTSS MPLS/MPKS
100 cars
K
a
b
500 shoes
L
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Producer Optimization (GE)
What happens to K/L ratios if w/r rose?
Answer Production of Car and Shoes at higher K/L
ratios. Why? But (K/L)c still greater than
(K/L)Sh .
100 cars
K
a
b
500 shoes
L
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SA US PPF

• US is capital abundant Hence PPF is biased
  towards capital-intensive good (Cars)

SA is labour abundant Hence PPF is biased
towards labour-intensive good (Shoes)
Cars
Cars
SA
US
100
80
Shoes
500
400
15
SA US PPF

• General equilibrium Psh/Pc such that production
  matches consumption gt tangent of Consumer
  indifference curve (CIC) and PPF

SA
US
Cars
Cars
100
80
Shoes
500
400
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Free Trade

• Differences in relative prices -gt trade
• (Psh/Pc)SA lt (Psh/Pc)US
• i.e. Shoes are relative cheap in SA, cars are
  relatively cheap in US
• World price settles
• (Psh/Pc)SA ? Pw ? (Psh/Pc)US
• Trade flows
• US exports Cars, SA exports shoes.

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SA US PPF
World price settles (Psh/Pc)SA ? Pw ? (Psh/Pc)US
SA
US
Cars
Cars
100
80
Eus
(Psh/Pc)SA
(Psh/Pc)US
Shoes
500
400
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Size does not matter for direction of trade
cars
Pus
US
B
PWorld
shoes
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Heckscher-Ohlin Theorem

• A country will export the good which intensively
  uses its relatively abundant factor
• US Capital abundant Cars capital intensive
• US exports cars
• SA Labour abundant Shoes Lab intensive
• SA exports Shoes
• NOTE Both countries still produce both goods

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Empirical evidence