CHAPTER F I V E

International
Economics
Tenth Edition

Factor Endowments and the

Heckscher-Ohlin Theory
Dominick Salvatore
John Wiley & Sons, Inc.

In this chapter:
Assumptions of the Theory

Factor Intensity, Factor Abundance, and the

Shape of the Production Frontier

Factor Endowments and the Heckscher-Ohlin
Theory
Factor-Price Equalization and Income
Distribution
Empirical Tests of the Heckscher-Ohlin Model

Assumptions of the Theory

Heckscher-Ohlin theory based on following

assumptions:
1.

2.

3.

Two nations (1 & 2) , two goods (X & Y), two

factors of production (L & K)
Technology is the same in both nations both
nations have the same production function
Commodity X is labor intensive, commodity Y is
capital intensive in both nations.

X requires relatively more labor (less capital) than Y.

Capital-labor ratio is less in the production of X

Assumptions of the Theory

4.

Constant returns to scale for X and Y in both

nations.

5.

6.

If a nation increases the amounts of L & K used in the

production of X (or Y) by 10%, the output of X (or Y)
increases by the same 10%.

Incomplete specialization in production in both

nations
Tastes (preferences) are equal in both nations.

If prices of X and Y are the same in both nations, both

nations will consume X and Y in the same proportion.

Assumptions of the Theory

7.

Both commodities and factors are traded in

perfectly competitive markets

8.

All consumers and produces are price-takers

In the long-run, prices of X & Y equal their cost of
production (including implicit costs) Zero Economic
Profit in LR.
Commodities and factors are homogenous (identical) in each
nation and internationally.

Perfect factor mobility within each nation, but not

between nations. That is, there is perfect internal,
but no international, factor mobility.

L & K freely move to the production of the commodity

where earnings are higher

Assumptions of the Theory

9.

10.

No transportation costs, tariffs or other barriers to

free trade.
All resources are fully employed in both nations

11.

Each nation produces on its PPF.

International trade between the nations is balanced.

Total value of exports equals total value of imports for

each nation.

Factor Intensity, Factor Abundance, and the

Shape of the Production Frontier
Factor Intensity
In a two-commodity, two-factor world,
commodity Y is capital intensive if the capitallabor ratio (K/L) used in the production of Y is
greater than K/L used in the production of X.

It is not the absolute amount of capital and labor

used in production of X and Y, but the amount of
capital per unit of labor that determines capital
intensity.

Factor Intensity, Factor Abundance, and the

Shape of the Production Frontier
Factor Intensity
Suppose that
The production of 1X in nation 1 requires 1K & 4L
The production of 1Y in nation 1 requires 2K & 2L
The production of 1X in nation 2 requires 2K & 2L
The production of 1Y in nation 2 requires 4K & 1L

Therefore, X is labor-intensive and Y is capitalintensive in both nations.

Factor Intensity, Factor Abundance, and the

Shape of the Production Frontier
Factor Abundance

In terms of physical units:

Nation 2 is capital abundant if the ratio of the

total amount of capital to the total amount of
labor (TK/TL) available in Nation 2 is greater than
that in Nation 1.

It is not the absolute amount of capital and labor

available in each nation, but the ratio of the total
amount of capital to the total amount of labor.

Factor Intensity, Factor Abundance, and the

Shape of the Production Frontier
Factor Abundance
In terms of relative factor prices:
Nation 2 is capital abundant if the ratio of the
rental price of capital to the price of labor time
(PK/PL) is lower in Nation 2 than in Nation 1.

Rental price of capital is usually considered to

be the interest rate (r), while the price of labor
time is the wage rate (w), so PK/PL = r/w.

It is not the absolute level of r that determines

whether a nation is K-abundant, but r/w.

Nation 2 is K-abundant, and

commodity Y is K-intensive

Nation 1 is L-abundant, and

commodity X is L-intensive

FIGURE 5-2 The Shape of the Production Possibilities Frontiers

(PPFs) of Nation 1 and Nation 2.

Factor Endowments and the Heckscher-Ohlin

Theory
Heckscher-Ohlin (H-O) theory is based on

two theorems:
1. The H-O theorem

A nation will export the commodity whose

production requires the intensive use of the nations
relatively abundant and cheap factor and import the
commodity whose production requires the intensive
use of the nations relatively scarce and expensive
factor.

Factor Endowments and the Heckscher-Ohlin

Theory
Heckscher-Ohlin (H-O) theory is based on two

theorems:
1. The H-O theorem

In short, the relatively labor-abundant nation exports

the relatively labor-intensive commodity and
imports the relatively capital-intensive commodity
Similarly, the relatively capital-abundant nation
exports the relatively capital-intensive commodity
and imports the relatively labor-intensive one
H-O Theorem Explains comparative advantage
rather than assuming it.

Factor-Price Equalization and Income

Distribution
Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. The factor price equalization theorem

International trade will bring about equalization in

the relative and absolute returns to homogenous
factors across nations.
In short, wages and other factor returns will be
the same after specialization and trade has
occurred.
Holds only if H-O theorem holds.

Factor-Price Equalization and Income

Distribution
Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. The factor price equalization theorem

International trade causes w to rise in Nation 1

(the low-wage nation) and fall in Nation 2. (the
high-wage nation), reducing the pre-trade
difference in w between nations.
Similarly, trade causes r to fall in Nation 1 (the
K-expensive nation) and rise in Nation 2. (the Kcheap nation), reducing the pre-trade difference
in r between nations.

Factor-Price Equalization and Income

Distribution
Heckscher-Ohlin (H-O) theory is based on

two theorems:
2. The factor price equalization theorem

Thus, international trade causes a

redistribution of income from the relatively
expensive (scarce) factor to the relatively cheap
(abundant) factor.

FIGURE 5-5 Relative FactorPrice Equalization.

Empirical Tests of the Heckscher-Ohlin Model

The Leontief Paradox

A 1951 test of the H-O theory

Showed that the pattern of trade did not fit the

conclusions of the H-O theorem.

Exports in the U.S. seemed to be labor intensive

when they should have been capital intensive.

Empirical Tests of the Heckscher-Ohlin Model

Source of the Leontief Paradox Bias

Assumed a two factor world which required

assumptions about what is capital and what is
labor.
Most heavily protected industries in U.S. were
L- intensive, reduced imports and increased
domestic production of L-intensive goods.
Only physical capital included as capital,
ignoring human capital (education, job training,
skills).