International Trade

The
Heckscher-Ohlin
Model

MAS ECO 3
 Explain how differences in
Heckscher-Ohlin Model resources generate a specific

Learning Goals pattern of trade.

Discuss why the gains from trade

will not be equally spread even
in the long run and identify the
likely winners and losers.

Understand the possible links

between increased trade and
rising wage inequality in the
developed world.
The Heckscher-Ohlin
Model
Eli Heckscher
Bertil Ohlin

“The country that is

abundant in a factor
exports the good
whose production is
intensive in that factor.”
 Heckscher-Ohlin
Assumptions Model

2 countries
Home & Foreign

2 goods
Food & Cloth

2 factors of
production (mobile)

Capital & Labor

factor intensity
at any given
wage-rental ratio,
production of one
of the goods will use a
higher ratio of
capital to labor
than production of
the other
labor-intensive good if its
production requires a higher
proportion of labor compared
to capital

capital-intensive good if its

production requires a higher
proportion of capital
compared to labor
 Heckscher-Ohlin
Assumptions Model

2 countries Cloth-labor intensive

Home & Foreign Food-capital intensive
2 goods
Food & Cloth

2 factors of
production (mobile)

Capital & Labor

 Heckscher-Ohlin
Assumptions Model

2 countries Cloth-labor intensive

Home & Foreign Food-capital intensive
2 goods
Food & Cloth Home-labor abundant
Foreign-capital abundant
2 factors of
production (mobile)

Capital & Labor

 Heckscher-Ohlin
Production functions Model

both Home & Foreign will

produce a certain amount of
Food and Cloth
 Heckscher-Ohlin
Assumptions Model

2 countries Cloth-labor intensive

Home & Foreign Food-capital intensive

2 goods
Home-labor abundant
Food & Cloth Foreign-capital abundant
2 factors of
production (mobile) Technology-same for H & F
Consumer Tastes/Preferences-
Capital & Labor same for H & F
Heckscher-Ohlin
Model
Heckscher-Ohlin
Model
 An increase in the supply of one factor of
production expands production possibilities,
but in a strongly biased way:
At unchanged relative goods prices, the
output of the good intensive in that factor
rises while the output of the other good
actually falls.
Heckscher-Ohlin
Model
 Generally, an economy will
tend to be relatively effective
at producing goods that are
intensive in the factors with
which the country is relatively
well endowed.
Heckscher-Ohlin
Model
Relative Prices and the Pattern of Trade

Why do the relative

prices before trade
differ between Home
and Foreign?
 Relative Prices and the Pattern of Trade
The relative prices before trade differ between Home and Foreign because of differences in
their factor endowments and production technologies.
In the context of the Heckscher-Ohlin model, countries have different abundances of factors
of production, such as labor and capital. For example, Home might have more capital relative
to labor, while Foreign might have more labor relative to capital. As a result:

Home would specialize in producing capital-intensive goods, which would lead to a lower
relative price for these goods compared to labor-intensive goods.
Foreign, with its abundance of labor, would specialize in labor-intensive goods, leading to
a lower relative price for labor-intensive goods in that country.

These differences in factor endowments cause variations in the supply conditions for each
good, leading to different equilibrium relative prices before trade. Once trade opens up,
these prices start to converge as countries exchange goods based on their comparative
advantage.
 Relative Prices and the Pattern of Trade

How does the

introduction of trade
impact consumer and
producer welfare in both
Home and Foreign?
 Relative Prices and the Pattern of Trade
The introduction of trade generally improves the welfare of both consumers and producers in Home and Foreign, but the
effects can vary between the two groups depending on which factor of production they rely on and the goods they
produce or consume.

For consumers:
Increased variety and lower prices: Trade allows consumers in both countries to access goods that were either
unavailable or more expensive before trade. As the relative prices of goods converge, consumers benefit from lower
prices, especially for goods that are relatively more expensive domestically. For example, Home consumers can buy
capital-intensive goods from Foreign at lower prices, and Foreign consumers can buy labor-intensive goods from Home
more cheaply.
Increased choice: Trade also expands the variety of goods available in both countries, enhancing consumer satisfaction.

For producers:
Producers of export goods benefit: Producers in each country that specialize in the good in which their country has a
comparative advantage (e.g., labor-intensive goods in Home, capital-intensive goods in Foreign) can expand their
market, leading to higher production and profits as they gain access to foreign consumers.
Producers of import-competing goods may lose: Producers in each country who compete with imported goods may
face lower prices and stiffer competition, which can reduce their profits or force them to adjust their production.

Overall, while consumers generally gain due to lower prices and more options, the impact on producers is mixed—
producers of exportable goods benefit from trade, while producers facing competition from imports may lose. However,
the overall welfare of both Home and Foreign improves due to the efficiency gains from trade and specialization according
to comparative advantage.
Trade and the
Distribution of Income

abundant factor-the resource of which a

country has a relatively large supply

scarce factor-the resource of which a

country has a relatively small supply
Trade and the
Distribution of Income Owners of a country’s
abundant factors
gain from trade, but

owners of a country’s
scarce factors lose.
Skill-Biased Technological Change and Income Inequality
Skill-Biased Technological Change and Income Inequality

Increasing trade integration between developed

and developing countries could potentially explain
rising wage inequality in developed countries.
However, little empirical evidence supports this
direct link. Rather, the empirical evidence suggests
that technological change rewarding worker skill
has played a much greater role in driving wage
inequality.
 “The world’s poorest countries cannot
find anything to export. There is no
resource that is abundant—certainly not
capital or land, and in small poor nations
not even labor is abundant.”
Discuss.
Factor Endowments: The H-O model assumes that countries will export goods that use their relatively abundant factors
intensively. If a poor country does not have abundant capital or land, they may still have an abundance of labor relative to
more developed nations. Even if labor is not abundant in absolute terms, it may be abundant relative to capital, which
could support exports of labor-intensive goods such as textiles, agriculture, or simple manufacturing products.
Labor Abundance in Relative Terms: Small, poor nations may not have large populations compared to bigger countries,
but they often still have a labor force that is cheap relative to more capital-intensive economies. This allows them to
produce labor-intensive goods at lower costs, which can be exported. Countries such as Bangladesh and Vietnam have
successfully used their abundant labor to develop competitive textile industries, even though they lack other significant
resources like capital or land.
Factor Price Equalization: The H-O model predicts that as trade opens, wages and capital returns across countries will
converge due to factor price equalization. This can be advantageous to poorer countries. Even if they initially struggle,
access to global markets can help them leverage their relatively abundant factors (e.g., labor) and gradually improve
income levels, enabling the country to upgrade its factor endowments over time.
Diversification and Investment: The H-O model also suggests that with trade and integration into global markets,
countries may attract foreign direct investment (FDI), which could improve their access to capital. With this new capital,
countries that previously lacked abundant resources can develop industries that cater to their comparative advantage,
transforming their export structure over time.
Challenges of Missing Comparative Advantage: For countries where no single factor is particularly abundant (as
suggested in the statement), the challenge is more complex. According to the H-O model, these countries might struggle
to find an industry in which they have a strong comparative advantage. In such cases, structural policies, education, and
investment in human capital are necessary to create the conditions for developing new comparative advantages, whether
in manufacturing, services, or knowledge-based industries.
“You are braver than
you believe, stronger
than you seem, and
smarter than you
think.” -- A.A. Milne