Chapter 4 Resources and Trade: The Heckscher-Ohlin Model · PDF fileChapter 4 Resources and Trade: The Heckscher-Ohlin Model Prepared by Iordanis Petsas To Accompany International

Chapter 4Chapter 4Resources and Trade:Resources and Trade:

The HeckscherThe Heckscher--Ohlin ModelOhlin Model

Prepared by Iordanis Petsas

To AccompanyInternational Economics: Theory and PolicyInternational Economics: Theory and Policy, Sixth Edition

by Paul R. Krugman and Maurice Obstfeld

Introduction

A Model of a Two-Factor Economy

Effects of International Trade Between Two-FactorEconomies

Empirical Evidence on the Heckscher-Ohlin Model

Summary

Appendix: Factor Prices, Goods Prices, and InputChoices

Chapter Organization

Slide 4-2Copyright © 2003 Pearson Education, Inc.

Introduction


Effects of International Trade Between Two-FactorEconomies

Empirical Evidence on the Heckscher-Ohlin Model

Summary

Appendix: Factor Prices, Goods Prices, and InputChoices

Introduction

In the real world, while trade is partly explained bydifferences in labor productivity, it also reflectsdifferences in countries’ resources. The Heckscher-Ohlin theory:

• Emphasizes resource differences as the only source oftrade

• 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


In the real world, while trade is partly explained bydifferences in labor productivity, it also reflectsdifferences in countries’ resources. The Heckscher-Ohlin theory:

• Emphasizes resource differences as the only source oftrade

• 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

Assumptions of the Model• An economy can produce two goods, cloth and food.

• The production of these goods requires two inputsthat are in limited supply; labor (L) and land (T).

• Production of food is land-intensive and productionof cloth is labor-intensive in both countries.

• Perfect competition prevails in all markets.



Assumptions of the Model• An economy can produce two goods, cloth and food.

• The production of these goods requires two inputsthat are in limited supply; labor (L) and land (T).

• Production of food is land-intensive and productionof cloth is labor-intensive in both countries.

• Perfect competition prevails in all markets.

Unit land input aTF ,in acres per calorie

A Model of a Two-Factor EconomyFigure 4-1: Input Possibilities in Food Production


//

Input combinationsthat produce onecalorie of food

Unit land input aLF ,in hours per calorie

• Factor Intensity– In a world of two goods (cloth and food) and two

factors (labor and land), food production is land-intensive, if at any given wage-rental ratio the land-labor ratio used in the production of food is greater thanthat used in the production of cloth:

TF/LF > TC/ LC

– Example: If food production uses 80 workers and200 acres, while cloth production uses 20 workersand 20 acres, then food production is land-intensiveand cloth production is labor-intensive.



• Factor Intensity– In a world of two goods (cloth and food) and two

factors (labor and land), food production is land-intensive, if at any given wage-rental ratio the land-labor ratio used in the production of food is greater thanthat used in the production of cloth:

TF/LF > TC/ LC

– Example: If food production uses 80 workers and200 acres, while cloth production uses 20 workersand 20 acres, then food production is land-intensiveand cloth production is labor-intensive.

CCFF

Wage-rentalratio, w/r

A Model of a Two-Factor EconomyFigure 4-2: Factor Prices and Input Choices


Land-laborratio, T/L

Factor Prices and Goods Prices• Stolper-Samuelson Theorem (effect):

– If the relative price of a good increases, holding factorsupplies constant, then the nominal and real return (interms of both goods) to the factor used intensively in theproduction of that good increases, while the nominaland real return (in terms of both goods) to the otherfactor decreases.

– The reverse is also true.



Factor Prices and Goods Prices• Stolper-Samuelson Theorem (effect):

– If the relative price of a good increases, holding factorsupplies constant, then the nominal and real return (interms of both goods) to the factor used intensively in theproduction of that good increases, while the nominaland real return (in terms of both goods) to the otherfactor decreases.


SS

Relative price ofcloth, PC/PF

A Model of a Two-Factor EconomyFigure 4-3: Factor Prices and Goods Prices



FFCC


(w/r)2

A Model of a Two-Factor EconomyFigure 4-4: From Goods Prices to Input Choices


SS

Land-laborRatio, T/L

Relativeprice ofcloth, PC/PF

(PC/PF)1 (TC/LC)2(TC/LC)1 (TF/LF)2(TF/LF)1

(w/r)2

(w/r)1

Increasing Increasing

(PC/PF)2

An increase in the price of cloth relative to that offood, PC/PF ,will:• Raise the income of workers relative to that of

landowners, w/r.• Raise the ratio of land to labor, T/L, in both cloth and

food production and thus raise the marginal product oflabor in terms of both goods.

• Raise the purchasing power of workers and lower thepurchasing power of landowners, by raising real wagesand lowering real rents in terms of both goods.



An increase in the price of cloth relative to that offood, PC/PF ,will:• Raise the income of workers relative to that of

landowners, w/r.• Raise the ratio of land to labor, T/L, in both cloth and

food production and thus raise the marginal product oflabor in terms of both goods.

• Raise the purchasing power of workers and lower thepurchasing power of landowners, by raising real wagesand lowering real rents in terms of both goods.

Resources and Output• How is the allocation of resources determined?

– Given the relative price of cloth and the supplies of landand labor, it is possible to determine how much of eachresource the economy devotes to the production of eachgood.



Resources and Output• How is the allocation of resources determined?

– Given the relative price of cloth and the supplies of landand labor, it is possible to determine how much of eachresource the economy devotes to the production of eachgood.

LFLabor used in food production OF

Increasing

Land

use

d in

clo

th p

rodu

ctio

nLand used in food production

A Model of a Two-Factor EconomyFigure 4-5: The Allocation of Resources


TF

LC

TC

Labor used in cloth productionIncreasing

Land

use

d in

clo

th p

rodu

ctio


1

F

C

OC

How do the outputs of the two goods change whenthe economy’s resources change?• Rybczynski Theorem (effect):

– If a factor of production (T or L) increases, then thesupply of the good that uses this factor intensivelyincreases and the supply of the other good decreases forany given commodity prices.




How do the outputs of the two goods change whenthe economy’s resources change?• Rybczynski Theorem (effect):

– If a factor of production (T or L) increases, then thesupply of the good that uses this factor intensivelyincreases and the supply of the other good decreases forany given commodity prices.


L2F L1

F

A Model of a Two-Factor EconomyFigure 4-6: An Increase in the Supply of Land

Labor used in food productionIncreasing

Land

use

d in

clo

th p

rodu

ctio


O1F

O2F


C

L2C

T1F

T1C

F1

L1C

T2F

T2C

1

Labor used in cloth productionIncreasing

Land

use

d in

clo

th p

rodu

ctio


F2

2

OC

Output offood, QF

Slope = -PC/PF2Q2

F

A Model of a Two-Factor EconomyFigure 4-7: Resources and Production Possibilities


TT1 TT2

Output ofcloth, QC

Slope = -PC/PF

Q2C

1Q1

F

Q1C

An increase in the supply of land (labor) leads to abiased expansion of production possibilities towardfood (cloth) production. The biased effect of increases (decreases) in resources

on production possibilities is the key to understandinghow differences in resources give rise to internationaltrade. An economy will tend to be relatively effective at

producing goods that are intensive in the factors withwhich the country is relatively well-endowed.



An increase in the supply of land (labor) leads to abiased expansion of production possibilities towardfood (cloth) production. The biased effect of increases (decreases) in resources

on production possibilities is the key to understandinghow differences in resources give rise to internationaltrade. An economy will tend to be relatively effective at

producing goods that are intensive in the factors withwhich the country is relatively well-endowed.

Assumptions of the Heckscher-Ohlin model:• There are two countries (Home and Foreign) that have:

– Same tastes

– Same technology

– Different resources– Home has a higher ratio of labor to land than Foreign

does

• Each country has the same production structure of atwo-factor economy.

Effects of International TradeBetween Two-Factor Economies


Assumptions of the Heckscher-Ohlin model:• There are two countries (Home and Foreign) that have:

– Same tastes

– Same technology

– Different resources– Home has a higher ratio of labor to land than Foreign

does

• Each country has the same production structure of atwo-factor economy.

Relative Prices and the Pattern of Trade• Factor Abundance

– Home country is labor-abundant compared to Foreigncountry (and Foreign is land-abundant compared toHome) if and only if the ratio of the total amount oflabor to the total amount of land available in Home isgreater than that in Foreign:

L/T > L*/ T*

– Example: if America has 80 million workers and 200 millionacres, while Britain has 20 million workers and 20 millionacres, then Britain is labor-abundant and America is land-abundant.

– In this case, the scarce factor in Home is land and inForeign is labor.



Relative Prices and the Pattern of Trade• Factor Abundance

– Home country is labor-abundant compared to Foreigncountry (and Foreign is land-abundant compared toHome) if and only if the ratio of the total amount oflabor to the total amount of land available in Home isgreater than that in Foreign:

L/T > L*/ T*

– Example: if America has 80 million workers and 200 millionacres, while Britain has 20 million workers and 20 millionacres, then Britain is labor-abundant and America is land-abundant.

– In this case, the scarce factor in Home is land and inForeign is labor.

• When Home and Foreign trade with each other, theirrelative prices converge. The relative price of clothrises in Home and declines in Foreign.

– In Home, the rise in the relative price of cloth leads to arise in the production of cloth and a decline in relativeconsumption, so Home becomes an exporter of clothand an importer of food.

– Conversely, the decline in the relative price of cloth inForeign leads it to become an importer of cloth and anexporter of food.



• When Home and Foreign trade with each other, theirrelative prices converge. The relative price of clothrises in Home and declines in Foreign.

– In Home, the rise in the relative price of cloth leads to arise in the production of cloth and a decline in relativeconsumption, so Home becomes an exporter of clothand an importer of food.

– Conversely, the decline in the relative price of cloth inForeign leads it to become an importer of cloth and anexporter of food.

RS

RS*

3


Figure 4-8: Trade Leads to a Convergence of Relative PricesRelative priceof cloth, PC/PF


RD

12

3

Relative qualityof cloth, QC + Q*

CQF + Q*

F

Heckscher-Ohlin Theorem:• A country will export that commodity which uses

intensively its abundant factor and import thatcommodity which uses intensively its scarce factor.



Heckscher-Ohlin Theorem:• A country will export that commodity which uses

intensively its abundant factor and import thatcommodity which uses intensively its scarce factor.

Trade and the Distribution of Income• Trade produces a convergence of relative prices.• Changes in relative prices have strong effects on the

relative earnings of labor and land in both countries:– In Home, where the relative price of cloth rises:

– Laborers are made better off and landowners are made worseoff.

– In Foreign, where the relative price of cloth falls, theopposite happens:

– Laborers are made worse off and landowners are made betteroff.

• Owners of a country’s abundant factors gain fromtrade, but owners of a country’s scarce factors lose.



Trade and the Distribution of Income• Trade produces a convergence of relative prices.• Changes in relative prices have strong effects on the

relative earnings of labor and land in both countries:– In Home, where the relative price of cloth rises:

– Laborers are made better off and landowners are made worseoff.

– In Foreign, where the relative price of cloth falls, theopposite happens:

– Laborers are made worse off and landowners are made betteroff.

• Owners of a country’s abundant factors gain fromtrade, but owners of a country’s scarce factors lose.

Difference between the specific factors model and theHeckscher-Ohlin model in terms of incomedistribution effects:• The specificity of factors to particular industries is

often only a temporary problem.– Example: Garment makers cannot become computer

manufactures overnight, but given time the U.S.economy can shift its manufacturing employment fromdeclining sectors to expanding ones.

• In contrast, effects of trade on the distribution ofincome among land, labor, and capital are more or lesspermanent.



Difference between the specific factors model and theHeckscher-Ohlin model in terms of incomedistribution effects:• The specificity of factors to particular industries is

often only a temporary problem.– Example: Garment makers cannot become computer

manufactures overnight, but given time the U.S.economy can shift its manufacturing employment fromdeclining sectors to expanding ones.

• In contrast, effects of trade on the distribution ofincome among land, labor, and capital are more or lesspermanent.

Factor Price Equalization• In the absence of trade: labor would earn less in Home

than in Foreign, and land would earn more.

• Factor-Price Equalization Theorem:– International trade leads to complete equalization in the

relative and absolute returns to homogeneous factorsacross countries.

– It implies that international trade is a substitute for theinternational mobility of factors.



Factor Price Equalization• In the absence of trade: labor would earn less in Home

than in Foreign, and land would earn more.

• Factor-Price Equalization Theorem:– International trade leads to complete equalization in the

relative and absolute returns to homogeneous factorsacross countries.

– It implies that international trade is a substitute for theinternational mobility of factors.

• Has international trade equalized the returns tohomogeneous factors in different countries in the realworld?

– Even casual observation clearly indicates that it has not.– Example: Wages are much higher for doctors, engineers,

technicians, mechanics and laborers in the United States andGermany than in Korea and Mexico.

– Under these circumstances, it is more realistic to saythat international trade has reduced, rather thancompletely eliminated, the international difference inthe returns to homogeneous factors.



• Has international trade equalized the returns tohomogeneous factors in different countries in the realworld?

– Even casual observation clearly indicates that it has not.– Example: Wages are much higher for doctors, engineers,

technicians, mechanics and laborers in the United States andGermany than in Korea and Mexico.

– Under these circumstances, it is more realistic to saythat international trade has reduced, rather thancompletely eliminated, the international difference inthe returns to homogeneous factors.


Table 4-1: Comparative International Wage Rates (United States = 100)


• Three assumptions crucial to the prediction of factorprice equalization are in reality untrue:

– Both countries produce both goods

– Both countries have the same technologies inproduction

– Both countries have the same prices of goods due totrade

• One thing the factor-price equalization theorem doesnot say is that international trade will eliminate orreduce international differences in per capita incomes.



• Three assumptions crucial to the prediction of factorprice equalization are in reality untrue:

– Both countries produce both goods

– Both countries have the same technologies inproduction

– Both countries have the same prices of goods due totrade

• One thing the factor-price equalization theorem doesnot say is that international trade will eliminate orreduce international differences in per capita incomes.


Table 4-2: Composition of Developing-Country Exports(Percent of Total)


Testing the Heckscher-Ohlin Model• Tests on U.S. Data

– Leontief paradox– Leontief found that U.S. exports were less capital-intensive than

U.S. imports, even though the U.S. is the most capital-abundantcountry in the world.

• Tests on Global Data– A study by Bowen, Leamer, and Sveikauskas tested the

Heckscher-Ohlin model using data for a large number ofcountries.– This study confirms the Leontief paradox on a broader level.

Empirical Evidence on theHeckscher-Ohlin Model


Testing the Heckscher-Ohlin Model• Tests on U.S. Data

– Leontief paradox– Leontief found that U.S. exports were less capital-intensive than

U.S. imports, even though the U.S. is the most capital-abundantcountry in the world.

• Tests on Global Data– A study by Bowen, Leamer, and Sveikauskas tested the

Heckscher-Ohlin model using data for a large number ofcountries.– This study confirms the Leontief paradox on a broader level.

Table 4-3: Factor Content of U.S. Exports and Imports for 1962




Table 4-4: Testing the Heckscher-Ohlin Model


• Tests on North-South Trade– North-South trade in manufactures seems to fit the

Heckscher-Ohlin theory much better than the overallpattern of international trade.

• The Case of the Missing Trade– A study by Trefler in 1995 showed that technological

differences across a sample of countries are very large.



• Tests on North-South Trade– North-South trade in manufactures seems to fit the

Heckscher-Ohlin theory much better than the overallpattern of international trade.

• The Case of the Missing Trade– A study by Trefler in 1995 showed that technological

differences across a sample of countries are very large.


Table 4-5: Trade Between the United States and South Korea,1992 (million dollars)



Table 4-6: Estimated Technological Efficiency,1983 (United States = 1)


Implications of the Tests• Empirical evidence on the Heckscher-Ohlin model has

led to the following conclusions:– It has been less successful at explaining the actual

pattern of international trade.

– It has been useful as a way to analyze the effects oftrade on income distribution.



Implications of the Tests• Empirical evidence on the Heckscher-Ohlin model has

led to the following conclusions:– It has been less successful at explaining the actual

pattern of international trade.

– It has been useful as a way to analyze the effects oftrade on income distribution.

The Heckscher-Ohlin model, in which two goods areproduced using two factors of production, emphasizesthe role of resources in trade.

A rise in the relative price of the labor-intensive goodwill shift the distribution of income in favor of labor:

• The real wage of labor will rise in terms of bothgoods, while the real income of landowners willfall in terms of both goods.

Summary


The Heckscher-Ohlin model, in which two goods areproduced using two factors of production, emphasizesthe role of resources in trade.

A rise in the relative price of the labor-intensive goodwill shift the distribution of income in favor of labor:

• The real wage of labor will rise in terms of bothgoods, while the real income of landowners willfall in terms of both goods.

For any given commodity prices, an increase in afactor of production increases the supply of the goodthat uses this factor intensively and reduces thesupply of the other good. The Heckscher-Ohlin theorem predicts the following

pattern of trade:

• A country will export that commodity which usesintensively its abundant factor and import thatcommodity which uses intensively its scarce factor.

Summary


For any given commodity prices, an increase in afactor of production increases the supply of the goodthat uses this factor intensively and reduces thesupply of the other good. The Heckscher-Ohlin theorem predicts the following

pattern of trade:

• A country will export that commodity which usesintensively its abundant factor and import thatcommodity which uses intensively its scarce factor.

Summary

The owners of a country’s abundant factors gainfrom trade, but the owners of scarce factors lose.

In reality, complete factor price equalization is notobserved because of wide differences in resources,barriers to trade, and international differences intechnology.

Empirical evidence is mixed on the Heckscher-Ohlin model.• Most researchers do not believe that differences in

resources alone can explain the pattern of worldtrade or world factor prices.


The owners of a country’s abundant factors gainfrom trade, but the owners of scarce factors lose.

In reality, complete factor price equalization is notobserved because of wide differences in resources,barriers to trade, and international differences intechnology.

Empirical evidence is mixed on the Heckscher-Ohlin model.• Most researchers do not believe that differences in

resources alone can explain the pattern of worldtrade or world factor prices.

Units of land usedto produce onecalorie of food, aTF

Appendix: Factor Prices, GoodsPrices, and Input Choices

Figure 4A-1: Choosing the Optimal Land-Labor Ratio


//

Units of labor used toproduce one calorieof food, aLF

1

Isocost lines


Figure 4A-2: Changing the Wage-Rental RatioUnits of land usedto produce onecalorie of food, aTF


//1

2

Units of labor used toproduce one calorieof food, aLF

Slope = - (w/r)2

Slope = - (w/r)1


Figure 4A-3: Determining the Wage-Rental Ratio

Land input


FF

CCSlope = - (w/r)

Labor input


Figure 4A-4: A Rise in the Price of Cloth

Land input


FF

CC1

Slope = - (w/r)1

CC2Slope = - (w/r)2

Labor input

Chapter 4 Resources and Trade: The Heckscher-Ohlin Model · PDF fileChapter 4 Resources and Trade: The Heckscher-Ohlin Model Prepared by Iordanis Petsas To Accompany International

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