2. The Heckscher-Ohlin Theorem
The Heckscher-Ohlin Theorem says that countries
will export products that use their abundant and
cheap factor of production and import products that
use the countries' scarce factor.

3. Cont…
The Heckscher-Ohlin theory:
Emphasizes resource differences as the only source of
trade
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

4. Introduction
General equilibrium mathematical model
of international trade
Developed by Eli Heckscher and Bertil Ohlin
 Developed on the Ricardian theory of IT,

6. The Heckscher-Ohlin Assumptions—Basics
There are
two countries, Home and Foreign
two goods, Cloth and Food, and
two resources, Labor and Land
 these are used to produce Cloth and Food

7. The Heckscher-Ohlin Assumptions—
Preferences
The preferences of all consumers in the world are
identical.
The preferences of any individual are such that the
Marginal Rate of Substitution is independent of the
scale of consumption.
 The MRS of Wine for Cheese is the additional amount of Wine
that would keep the individual's level of happiness unchanged
even after the consumption of Cheese is reduced by one unit.
Under this assumption, if the amounts of Cheese and Wine being
consumed are, say, doubled, then the MRS remains unchanged. In
other words, the MRS does not change if the ratio of the amounts
of Cheese and Wine consumed, Cheese/ Wine, does not change.

8. The Ricardian Assumptions—Preferences
The preferences of all consumers in the world are
identical.
For any individual, the Marginal Rate of
Substitution is independent of the scale of
consumption.
An individual’s MRS of wine for cheese is the maximum
amount of wine that he/she would be willing to pay for
one unit of cheese.
Under this assumption, if the amounts of Cheese and
Wine being consumed are, say, doubled, then the MRS
remains unchanged.
In other words, the MRS does not change if the ratio of
the amounts of Cheese and Wine consumed, Cheese/
Wine, does not change.

9. Marginal Rate of Substitution
Cheese Wine Cheese- MRSWC
consumed consumed Wine Ratio
(C) (W) (C/W)
10 20 0.5 2
600 1200 0.5 2
10 5 2 1.6

10. The Heckscher-Ohlin Assumptions—
Markets
All markets are perfectly competitive.
That is, no buyer or seller of a commodity has the
power to affect the price of the commodity by
himself.
 More specifically, the market for a commodity is
said to be perfectly competitive if:
 There are many sellers
 There are many buyers
 All sellers sell the exact same product
Individuals make decisions so as to maximize
happiness, whereas
Firms make decisions so as to maximize profits

11. The Heckscher-Ohlin Assumptions—
Governments
Governments do not interfere with the smooth
functioning of markets
There are no taxes, subsidies, tariffs, quotas, etc.
However, although there is free trade in goods and
services, there is no cross-border movement of
resources, such as labor

12. The Heckscher-Ohlin Assumptions—
Technology
Technological knowledge is the same in both
countries
Goods are produced (with land and labor) using
technologies that satisfy Constant Returns to Scale.
That is, if the producer of a commodity, say, doubles
the amounts used of all resources, then the amount
produced will have to double also.

13. The Heckscher-Ohlin Assumptions—Factor
Abundance
Home has a higher ratio of labor to land than
Foreign does.
That is, if TH, TF, LH, and LF denote the amounts of T
(land or territory) and L (labor) that Home and Foreign
are endowed with, then LH / TH > LF/ TF.
L/T may be informally interpreted as the number of
workers per acre of land.
Home is said to be the “labor-abundant” country and
Foreign is the “land-abundant” country.

14. The Heckscher-Ohlin Assumptions—Factor
Intensities
The production of food is land-intensive and the
production of cloth is labor-intensive
That is, the number of workers per acre (L/T) is always
higher in cloth production than in food production

15. Prices of Goods
Let PC and PF denote the nominal prices of cloth and
food.
Then, PC/PF is the relative price of cloth (in units of
food) and
PF/PC is the relative price of food (in units of cloth)
See earlier lecture

16. Prices of Factors
Let w be the nominal price (or, wage) of labor.
Let r be the nominal price (or, rent) of land
Then w/r is the relative price of labor (in units of
land) and
r/w is the relative price of land (in units of labor)
Example: If w = $10 per hour for one worker and r = $100
per hour for one acre of land, then the relative wage for
one worker is 1/10 acres of land and the relative rent on
an acre of land is 10 hours of labor.

17. Nominal Prices
The nominal price of a commodity is simply the
number of dollars (or any other relevant unit of
account) that must be paid to buy one unit of the
commodity
For example, the nominal price of labor—also called
the nominal wage—may be $8 per hour

18. Real Prices
The real price of commodity X, in units of commodity
Y, is the amount of Y that costs the same as one unit
of X
For example, if the nominal price of labor is $8 per
hour and the nominal price of a cup of coffee is $2,
then the real price of labor is 4 cups of coffee per hour
Real prices are also called relative prices

19. Real and Nominal Prices
Real Price of X, in units of Y, is equal to Nominal
Price of X / Nominal Price of Y
So, if w is the nominal wage and P is the nominal
price of a cup of coffee, then the real wage is w / P.
For example, if w is $8 per hour and P is $2, then the
real wage is w / P = 8/2 = 4 cups of coffee per hour, as
in the previous slide.

20. As labor becomes more
Relative expensive relative to
price of land, cloth, which is
cloth,
PC/PF
labor-intensive in
FPGP
production, finds itself
at a disadvantage and
becomes relatively
17
more expensive
compared to food
As both Home and
Foreign use the same
technologies, the same
5 Wage-rent FPGP curve is applicable
ratio, w/r in both countries

21. Under free trade, the
Relative relative price of cloth
price of will be the same in both
cloth,
PC/PF
countries
FPGP
Therefore, the wage-
rent ratio will also be
17 the same in the two
countries
5 Wage-rent
ratio, w/r

22. As labor becomes
Cloth relatively more
Wage-rent production expensive, relatively
ratio, w/r Food more land is used in
production
production…
… of both food and
cloth
But the number of acres
5
of land per worker is
always higher in food
production, reflecting
the assumption that
4 Acres of food production is land
12
Land per intensive
worker, T/L

23. As both Home and
Foreign use the same
Cloth
Wage-rent technologies, these two
production
ratio, w/r Food curves must be true in
production both countries.
As free trade equalizes the
wage-rent ratio worldwide,
acres of land per worker in
cloth production must be the
5
same worldwide.
Same must be true for food
production.
Therefore, Foreign, which has
4 12 Acres of
Land per more land per worker than
worker, T/L Home, must produce relatively
more food …

24. Relative Supplies
Therefore, if the same w/r prevails in both
countries, then
QF/QC must be higher in Foreign than in Home.
Equivalently,
QC/QF must be higher in Home than in Foreign.
This result is called the Rybczynski effect; see the
section “Resources and Output” in the textbook

25. Relative Supplies
From the FPGP Curve in Fig. 4-6, any particular
value of w/r is linked to a specific value of PC/PF.
Therefore, if the same w/r prevails in the two
countries, then the same PC/PF must also prevail in
the two countries. And at that common value of
PC/PF …
QF/QC must be higher in Foreign than in Home.
Equivalently,
QC/QF must be higher in Home than in Foreign.

26. In Figure 4-5, we saw that
at w/r = 5, Foreign must
RSFOREIGN produce relatively more
Relative
price of food and Home must
RSHOME
cloth, produce relatively more
PC/PF cloth.
In Figure 4-6 we saw that
w/r =5 corresponds to PC/PF
17
= 17.
Therefore, Home must
produce relatively more
cloth at PC/PF = 17, or
indeed at any other relative
price.
Yards of cloth produced
As cloth becomes more expensive relative to per calorie of food
food, the output of cloth will increase relative produced, QC/QF
to food, Therefore, the relative supply curves
slope upward.

27. The H-O assumptions
about preferences imply
Relative that that consumer
price of
behavior can be
cloth,
PC/PF summarized by this
Relative Demand curve
and that the same curve is
17 true in both Home and
Foreign
3 Yards of cloth consumed
In this figure, when the price of a yard of cloth is 17 times per calorie of food
the price of a calorie of food, the number of yards of consumed, QC/QF
cloth consumed is 3 times the number of calories of food
consumed, for every individual worldwide. Why isn’t the
latter ratio different for different people?

28. Relative Demands
Let’s say that Alex consumes 3 times as many yards of
cloth as calories of food (relative demand is QC/QF = 3)
when a yard of cloth is 17 times as expensive as a
calorie of food (relative price PC/PF = 17)
If Alex’s income changes, his relative demand should
not change because MRS is independent of the scale
of consumption

29. Relative Demands
Since identical preferences have been assumed, if
the relative price of cloth is PC/PF = 17, then Betty’s
relative demand must also be QC/QF = 3
irrespective of Betty’s income
Therefore, the same relative demand curve
represents everybody
Therefore, the same relative demand curve
represents both Home and Foreign

30. Figure 4-11: Relative Supplies and
Demands
 The relative supplies
and demands can be
combined to find the
RSFOREIGN autarky relative prices in
Relative Home and Foreign
price of RSHOME
cloth,
 Clearly, they are
PC/PF different
 Therefore, trade will
occur if it is allowed
 Since Home and Foreign
Foreign differ only in their
relative factor
endowments, that
Home RD difference must be the
reason why trade occurs
Yards of cloth
produced per calorie
of food produced,
QC/QF

31. Who will export what?
In autarky, the labor- PC/PF
intensive good is relatively
cheaper in the labor-
abundant country Foreign
autarky
Therefore, under free trade,
the labor-intensive good is Free
exported by the labor- Trade
Home
abundant country…
… and the land-intensive
good is exported by the land- Foreign : land abundant, labor scarce
Home: land scarce, labor abundant
abundant country Cloth: labor intensive production
Food: land intensive production

32. The Heckscher-Ohlin Theorem
To repeat, when trade occurs, the labor-
abundant country (Home) exports the labor-
intensive good (cloth) and
The land-abundant country (Foreign) exports
the land-intensive good (food)
In general, each country exports the good
that makes intensive use of the resource
that is abundant in that country
This is called the Heckscher-Ohlin Theorem
See the section “Relative Prices and the Pattern of
Trade” in chapter 4 of the textbook

33. Goods Prices: from autarky to
free trade
In autarky, the labor- PC/PF
intensive good is relatively
cheaper in the labor-
abundant country Foreign
autarky
Free trade makes relative
prices equal everywhere Free
Trade
Home
Therefore, the labor-intensive
good becomes more
expensive in the labor-
abundant country, and less Foreign : land abundant, labor scarce
Home: land scarce, labor abundant
expensive in the labor-scarce Cloth: labor intensive production
country. Food: land intensive production

34. Fig. 4-11 showed that,
Relative in autarky, the relative
price of
price of cloth is higher
cloth,
PC/PF
in Foreign
FPGP
Therefore, in autarky,
the wage-rent ratio
Foreign must also be higher in
Foreign
Free Trade
Free trade makes the
Home wage-rent ratio the
same in the two
countries
Home Foreign Wage-rent
ratio, w/r
Free Trade

35. Factor Prices: from autarky to
free trade
PC/PF w/r
In autarky, the wage-rent ratio
is higher in the labor-scarce
country and lower in the labor- Foreign
abundant country autarky
When autarky ends and free Free
trade begins, the wage-rent Trade
Home
ratio falls in the labor-scarce
country and rises in the labor
abundant country Foreign : land abundant, labor scarce
Home: land scarce, labor abundant
Cloth: labor intensive production
Food: land intensive production

37. Real Wage and Real Rent
w Nominal wage: currency earned per hour of a worker’s labor
w/PC Real wage: yards of cloth purchasable with the nominal wage
w/PF Real wage: calories of food purchasable with the nominal wage
r Nominal rent: currency earned per hour per acre of land
r/PC Real rent: yards of cloth purchasable with the nominal rent
r/PF Real rent: calories of food purchasable with the nominal rent

38. Marginal Product of a Resource
The Marginal Product (MP) of labor in cloth
production is the additional amount of cloth that
would be produced if an additional unit of labor is
employed
We can similarly define
 Marginal Product of labor in food production,
 Marginal Product of land in cloth production, and
 Marginal Product of land in food production

39. Marginal Product of a Resource
See page Figure 7-2 of the textbook for more on the
Marginal Product.

40. Example: Level of Resource Use
Suppose an additional worker produces an
additional 5 yards of cloth in one hour’s work.
Then MP = 5.
See page Figure 7-2 of the textbook for more on the
Marginal Product.
Therefore, to make one additional yard of cloth,
you need only 1/5 of a worker.
In general, the labor needed to make one unit of
cloth can be calculated as 1/MP
Marginal Cost is the additional cost of an
additional unit of output
Therefore, MC = w × (1/MP) = w/MP

41. Price = Marginal Cost
If P > MC at the current level of production,
additional production would increase profit
If P < MC at the current level of production,
reduced production would increase profit
Therefore, profit is maximized only if P = MC
Therefore, if a good is being produced, P = MC
must be true

42. Real Wage and Real Rent
Therefore, P = MC = w / MP w
Therefore, w/P = MP = MPLC
This implies that the real wage in
units of, say, cloth is the Marginal
PC
Product of labor in the production
of cloth
r
Similarly, the real rent in units of
food is the Marginal Product of
= MPTF
land in food production PF

43. Real Factor Rewards and Productivity
In general, the real payment to a resource is equal
to its productivity (or, marginal product)
This is the main conclusion of the Marginal
Productivity Theory of Income Distribution

44. Factor Use and Factor Productivity—
Labor-Abundant Country
Cloth
Wage-rent production
ratio, w/r Food
 We saw earlier that when production
autarky ends and free trade
begins w/r rises in the labor-
abundant country (Home). Foreign
Therefore,
 More land is used per worker Free trade
 in cloth production and in
food production
Home
 This makes labor more
productive…
 …and land less productive
 Therefore,
 w/PC and w/PF both increase, and
 r/PC and r/PF both decrease. Acres of
• Abundant resource Land per
benefits from Foreign : land abundant, labor scarce worker, T/L
globalization Home: land scarce, labor abundant
• Scarce resource loses Cloth: labor intensive production
Food: land intensive production

45. Factor Use and Factor Productivity—
Land-Abundant Country
Cloth
Wage-rent production
ratio, w/r Food
 When autarky ends and free production
trade begins w/r falls in the
land-abundant country
(Foreign). Therefore, Foreign
 Less land is used per worker
Free trade
 in cloth production and in
food production
 This makes labor less Home
productive…
 …and land more productive
 Therefore,
 w/PC and w/PF both decrease,
and
 r/PC and r/PF both increase.
Acres of
• Abundant resource Land per
benefits from Foreign : land abundant, labor scarce worker, T/L
globalization Home: land scarce, labor abundant
• Scarce resource loses Cloth: labor intensive production
Food: land intensive production

46. Trade: Who Gains and Who Loses?
In short, each country’s abundant resource benefits
from trade and
Each country’s scarce resource loses from trade

47. Factor Price Equalization
Cloth
Free trade equalizes Wage-rent production
the wage-rent ratio ratio, w/r Food
Therefore, the land- production
per-worker ratio in
cloth production is Foreign, autarky
also equalized
This equalizes the Free trade
productivity of
labor in cloth
production in the Home, autarky
two countries
This equalizes w/PC
in the two countries
In a similar way, Acres of
w/PF, r/PC, and r/PF Land per
each become Foreign : land abundant, labor scarce worker, T/L
equalized Home: land scarce, labor abundant
worldwide Cloth: labor intensive production
Food: land intensive production

48. Marginal Marginal Productivity of Labor
Productivity = Real Wage, w/PC
These curves reflect
Diminishing Returns to
each resource, which, in
turn, is a consequence of
the assumption of
Constant Returns to Scale
Marginal Productivity of Land
= Real Rent, r/PC
Acres of land per Similar curves can
worker, T/L be drawn for food
production

49. Factor Price Equalization
We saw earlier that free trade makes w/r equal in
Home and Foreign
Since both countries use the same technology, the
equalization of w/r implies that the number of
workers used per acre of land in the production of,
say, cloth will also become the same in both countries

50. Factor Price Equalization
Therefore, the productivity (or MP) of labor in the
production of cloth will become the same in both
countries and
The productivity (or MP) of land in the production of
cloth will become the same in both countries

51. Factor Price Equalization
Therefore, the real wage in units of cloth, w/PC,
will become the same in both countries (since the
real wage is equal to the marginal product) and
r/PC will become the same in both countries
In the same way, one can show that
w/PF will become the same in both countries and
r/PF will become the same in both countries.

52. Factor Price Equalization Theorem
The Factor Price Equalization Theorem: When there
is free trade in goods, the real reward for any
resource (in units of either good) becomes the
same in both countries!
An implication of this result is that if there is free trade
in goods, resources will have no incentive to move from
one country to another

53. Factor Price Equalization Theorem
Heckscher-Ohlin theory implies FPE.
But does FPE imply that free trade will make
everybody equally rich?
Certainly not!
Not every individual is endowed with the same amount
of resources

54. How accurate is the Heckscher-Ohlin
theory?
Sadly, it’s not very accurate by itself
It explains North-South trade quite well…
But not trade within the North
But, if modified to take cross-country differences
in technology into account, it fits the data well
So, a theory that combines the insights of Ricardo
and Heckscher-Ohlin might be best

55. The contribution of Heckscher-Ohlin theory
The theory’s main contribution is to point out that
cross-country differences in relative resource
availability can explain trade
It does not claim that differences in relative
resource availability are the only reason why trade
occurs

56. Criticism
Poor predictive power
Factor equalization theorem
Identical production function
Capital as endowment
Homogeneous capital
No unemploymnent
No room for firms

58. List of Economies by GDP
List by the International Monetary Fund(2011)

61. Growth Rate of major economies

62. 10 largest economies in 2030

63. China
Current GDP (IMF-list): $10,050
GDP 2015 (IMF-estimate): $17,120
Projected GDP growth rate (real): 11%
Estimated GDP 2030: $83,778

64. United States:
Current GDP (IMF-list): $14,256
GDP 2015 (IMF-estimate): $18,029
Projected GDP growth rate (real): 4.4%
Estimated GDP 2030: $33,785

65. India
Current GDP (IMF-list): $4,001
GDP 2015 (IMF-estimate): $6,384
Projected GDP growth rate (real): 9.8%
Estimated GDP 2030: $25,942

66. Japan
Current GDP (IMF-list): $4,308
GDP 2015 (IMF-estimate): $5,070
Projected GDP growth rate (real): 3.3%
Estimated GDP 2030: $8,266

67. Russia
Current GDP (IMF-list): $2,218
GDP 2015 (IMF-estimate): $2,944
Projected GDP growth rate (real): 5.8%
Estimated GDP 2030: $6,878

68. Brazil
Current GDP (IMF-list): $2,181
GDP 2015 (IMF-estimate): $2,878
Projected GDP growth rate (real): 5.7%
Estimated GDP 2030: $6,611

69. Germany
Current GDP (IMF-list): $2,932
GDP 2015 (IMF-estimate): $3,449
Projected GDP growth rate (real): 3.3%
Estimated GDP 2030: $5,619

70. Indonesia
Current GDP (IMF-list): $1,027
GDP 2015 (IMF-estimate): $1,531
Projected GDP growth rate (real): 8.3%
Estimated GDP 2030: $5,075

71. Mexico
Current GDP (IMF-list): $1,549
GDP 2015 (IMF-estimate): $2,067
Projected GDP growth rate (real): 5.9%
Estimated GDP 2030: $4,907

72. United Kingdom
Current GDP (IMF-list): $2,181
GDP 2015 (IMF-estimate): $2,642
Projected GDP growth rate (real): 3.9%
Estimated GDP 2030: $4,702