The Heckscher-Ohlin

Model

Appleyard & Field (& Cobb): Chapters 8 &

9
(Krugman & Obstfeld: Chapter 3 & 4)

1
Assumptions of the Heckscher-
Ohlin-(Samuelson)-Model
1. Two countries, two (homogeneous) goods and
two (homogeneous) factors of production
2. Identical technology, different factor
endowments
3. Constant returns to scale
4. Different factor intensities in production
5. Factors perfectly mobile inside each country
and immobile between the countries
6. (Identical preferences among everyone)
7. Perfect competition in all markets
→ (price of labour) w = MPPL*P, (price of capital) r =
MPPK*P
8. (No transportations costs)
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Factor Endowments
• Countries differ in their relative factor
endowments
• Notation: K=capital, L=labour, r = price of capital, w = price of
labour
• Physical definition: (K/L)1 > (K/L)2  country
1 is capital-abundant (labour-scarce), country 2
is labour-abundant (capital-scarce)
• Price definition: (r/w)1 < (r/w)2  country 1 is
capital-abundant, country 2 is labour-abundant
• Given assumptions of perfect competition +
identical technology and preferences, the
physical and price definitions are identical
3
Factor Endowments
Low K/L ratio High K/L ratio

Capital (K)
Capital (K)

Labour (L)

Labour (L)

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Commodity Factor Intensity
• Good X is capital-
Capital
intensive and
Isoquant for X
good Y labour-
intensive if KX/LX
> KY/LY for all relative
factor prices (r/w)  the
firm always maximizes
profits / minimizes cost by
using relatively more Isoquant for Y
capital in producing X
than in producing Y
Labour

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 Gains from Trade in the
Hecksher-Ohlin Model
Capital Identical
Intensive preferences
Good in both
countries
(e.g. paper)
PPF of (PC/PP)FA > (PC/PP)HA
“foreign
Notation: ”
F = “foreign” country
H = “home”
C=cloth
P=paper (PC/PP)FA

A=autarky
FT=free trade
PPF of (PC/PP)HA

the
“home”
country

Labour intenstive
Good (e.g
6 clothes)
at here “foreign” country looks like Finland and “home” like China
 Gains from Trade in the
Hecksher-Ohlin Model
Capital
Intensive
Good
(e.g. paper)
(PC/PP)FA > (PC/PP)FT > (PC/PP)HA
Notation:
F = “foreign”
H = “home”
C=cloth
P=paper (PC/PP)FA

A=autarky
FT=free trade
(PC/PP)HA

(PC/PP)FT

trade trade Labour intenstive

Good (e.g
7 clothes)
Heckscher-Ohlin Theorem
Country will export the commodity that
uses relatively intensively its relatively
abundant factor of production
• i.e. what we saw in the previous graph
• example: China is labour-abundant and
Finland is capital-abundant i.e. (K/L)H < (K/L)F
and (r/w)H > (r/w)F
→ China exports labour-intensive products
(e.g. clothes) to Finland and imports capital-
intensive products (e.g. paper) from Finland

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Factor Price Equalization
• Autarky → Free trade
o relative prices of final goods become identical
 relative price of paper increases (=relative price of clothes
decrease) in Finland

→ e.g. Finland produces more paper, China more

clothes
• Since producing paper is more capital intensive,
demand for capital increases (demand curve shifts
upwards) and demand for labour decreases
(downwards) in Finland → w ↓ r ↑
• Similarly in China, demand for labour increases
and demand for capital decreases → r ↓ w ↑
• In equilibrium all prices (including factor
prices) are identical
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 Factor Price Adjustments
Finland China
r
r
capital markets

SK SK

rCA

rFFT DK
rC FT

DK
rFA
K K

w
labour markets

w
SL SL
w FA

wFFT DL
wCFT

DL
w CA
K
L 10
 Income Distribution and Trade:
the Stolper-Samuelson
Theorem
• Trade affects both the prices of goods and the
prices of factors of production: What then is the
impact of trade on distribution of real income?
o wages decrease in Finland, but also the price of
clothes decreases (i.e. you need less money to buy
the same amount of clothes). Which effect
dominates?
• Stolper-Samuelson Theorem: real income of the
owners of abundant factor increases and the
real income of owners of scarce factor decreases
o Think about the labour abundant country (e.g.
China): Free trade → r ↓ w ↑ → capital/labour ratio ↑
→ labour productivity ↑ → real wages ↑

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W. Stolper & P. Samuelson (1941): International Factor-Price Equalisation Once Again. Economic
Why Don’t We Observe Price
Equalization?
• In reality most of the assumptions needed
for price equalization do not hold
o e.g. differences in productivity /
technology, transportation costs, tariffs,
subsidies, imperfect competition,
unemployed resources, externalities…
• However, the model provides an
important insight on the tendency of
price movements due to increasing
international trade
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 Trade as a Substitute for
Capital and Labour Flows
• Suppose that there is no international trade
of goods, but capital and labour are
internationally perfectly mobile
• Capital will then flow to the labour-
abundant country and labour to the capital-
abundant country until the factor prices are
equal in both countries
• When all markets are perfectly competitive,
this must imply equal commodity prices
→ Trade and factor mobility are perfect
substitutes in the HO-model
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R.A. Mundell (1957): International Trade and Factor Mobility. American Economic
Changing Assumptions
1. Two countries, two (homogeneous) goods
and two (homogeneous) factors of production
2. Identical technology, different factor
endowments
3. Constant returns to scale
4. Different factor intensities in production
5. Factors perfectly mobile inside each country
Specific factors
and immobile between the countries
6. Identical preferences among everyone
7. Perfect competition in all markets
8. No transportations costs
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 Specific-Factors Model
Three factors of production:
1) L = mobile labour Good Y
2) KX = immobile capital for
producing good X
3) KY = immobile capital for A
producing good Y “standard” PPF
→ Specific-factors PPF will lie inside
“standard” PPF, except in the (initial) point
A (production after trade will take place in Specific-
point C, rather than in point B). Note that factors
trade still leads to expansion of the C B
PPF
industry that uses the abundant factor
more intensively (labour moves from
production of Y to X; A → C).
o A natural way to think about this is to consider
the specific-factors PPF to represent short-run
and the “standard” PPF to represent long-run Good X
implications 15
Trade and Income Distribution
in the Specific-Factors Model
• Assume that the relative price of good X increases
due to introduction of free trade, i.e. (PX/PY) ↑:
→ Production of X ↑ Production of Y ↓
→ Labour flows to production of good X
→ rX ↑ rY ↓ [increased demand for KX]
→ KX/LX ↓ KY/LY ↑ [KX and KY are fixed]
→ MPPLX ↓ MPPLY ↑ [less capital per labour in X, more in
Y]
→ w/PX ↓ w/PY ↑ [w=MPPLX*PX = MPPLY*PY]

o Owners of KX benefit, owners of KY lose

o Ambiguous effect on mobile factor (labour)
o If workers consume only X their real wage has fallen, if
only Y real wage has risen  impact on real wages
depends on consumption bundles
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Summary of the Heckscher-
Ohlin model
• Differences in relative endowments
of factors of production →
Comparative advantage
• Trade leads to
o Expansion of the industry using
intensively the abundant factor of
production (Heckscher-Ohlin Theorem)
o Changes in distribution of income
(international factor price equalization, Stolper-
Samuelson theorem)
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 Is trade beneficial in the HO-
Model?
• We have seen that trade benefits some* and hurts
others**. So, do the gains outweigh the losses?
• To answer this question would require comparison of
(subjective) welfares (do the losers suffer more than the
winners enjoy), which is outside of the province of
economic analysis.
• However, we can ask: Could those who gain
compensate those who lose, and still be better off?
The answer is, yes.
• Trade expands the economy’s choices (enables
consumption outside PPF). Hence, in principle, it is
possible to redistribute income in such a way that
everyone will gain. Of course, this is not to say that
redistribution would actually happen.
• The presence of loser and winners in the real world is
probably the most important reason why trade is not free.
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of the abundant / export specific factor; ** owners of the scarce / import specifi