Assumptions IN THE Heckscher Ohlin Model Economics Essay

Introduction

Eli Heckscher (1919) and Bertil Ohlin (1933) found the basis for crucial and substantive theoretical developments of international trade by emphasizing the relationships between the composition of countries' factor endowments and product trade patterns. The Heckscher-Ohlin (H-O) theory is the simplest reason why countries involve in trade of goods and services with other countries. Heckscher-Ohlin model, which is the overall equilibrium mathematical style of international trade theory, is made on the Ricardian theory of comparative benefits by causing prediction on trade patterns and production of goods predicated on the factor endowments of nations (Learner 1995).

Assumptions of the Heckscher- Ohlin Model

The pursuing assumptions pertain to the 2*2 model of Heckscher-Ohlin.

It is assumed that there are only two nations (1 and 2) with two goods for trade (X and Y) and two factors of development (capital and labour).

For producing the products, both nations use the same technology plus they use even factors of production.

In both countries, good X is labour intense and Y is capital intensive.

The preferences and choices of both countries are the same (both countries can be symbolized in the same indifference curve).

In both nations, the assumption of constant returns to size does apply for the production of goods X and Y.

In both nations, specialization in development is not complete.

Goods and factor marketplaces in both nations are properly competitive.

There is accessible perfect flexibility of factors of development within each country though international ability to move is extremely hard.

There are no restrictions or limits to the free circulation of international trade. That's, there are present no travel costs, tariffs, or like other obstructions either to control or to limit the exports or imports.

It is assumed that there exists full employment of most resources in both nations. That's, there will not be any under applied source in either land.

The exports and imports between the nations are well balanced. This means that the total value of the exports will be add up to the total value of imports in both nations.

Implications of the Assumptions

The assumptions are created in order to depict the idea in a two-dimensional shape. It is also implied that both countries have access to and use the same standard development techniques. The labour-capital percentage (L/K) of item X is higher than that of Y in both countries with the same comparative prices of factors. As frequent returns to range is assumed, upsurge in the quantity of labour and capital will result in the proportionate increase in the outcome also. Another implication is that though free international trade exists, both of the countries produce both goods and it could be presumed that both countries are not small in proportions.

As the tastes and choices related to demand are indistinguishable in both countries, if the comparative prices of the goods are equal, the consumption of goods X and Y will maintain the same proportion in both countries. Moreover, in both countries producers, traders and individuals are too small to affect the item prices. Mobility of factors of production means that capital and labour are free to move from areas or market sectors of lower prices (earnings) to people of higher prices (profits) until revenue become same identical in all areas or industries. That is, price equalization theory is implied here. International differences in the earnings exist because of the factor immobility in the lack of international trade.

The assumption of imperfect production specialization means that the process of specialty area in production carries on until the item prices (either comparative or utter) prices will be the same in both countries. Again, if the travelling costs, tariffs or any other limitation are allowed, field of expertise will continue only until price variations by significantly less than or equal to the expenses or tariffs.

The Heckscher-Ohlin Model

Heckscher-Ohlin model is generally referred to as two countries, two goods and two factors model (2x2x2 model). This formulation of HO model was mathematically produced by Paul Samuelson. The goal of the model is to predict the structure of international trade in goods between the two countries on the basis of differences in factor endowments in both countries.

Definition: A nation exports the goods which can be produced out of its relatively numerous and cheap factors or resources and imports the item which is produced out of relatively scarce factors or resources. In another words, relatively labour considerable country exports relatively labour intense commodity and imports the relatively capital-intensive commodity. Country 1 exports commodity X because X is the Labor (L) rigorous item and L is relatively cheap and abundant element in country 1. Country 2 exports product Y because Y is the Capital (K) intensive product and K is relatively cheap and numerous element in country 2.

The theory implicates a couple of things: first, different source conditions in conditions of source of information endowments make clear comparative edge and second, countries export goods that use abundant and cheap factors of production and import goods that use scarce and expensive factors.

According to Heckscher-Ohlin theory, international and interregional distinctions in production costs occur due to the differences in the supply of factors of development. Under free trade, countries export the commodities whose production requires intense use of abundant factors and import the goods whose production requires the scarce factors. Hence, international trade compensates for the uneven geographic syndication of factors of creation. The theory offers insight to the actual fact that commodities are the bundles of factors (land, labour and capital). Thus, the exchange of commodities is indirect arbitrage of factors of creation and the copy of services of in any other case immobile factors from areas where factors are abundant to areas where these are scarce.

The H-O theorem recognizes the basic reason for comparative advantage and international trade as different factor plethora or factor endowments among nations. As a result of this particular reason, the theory is recognized as factor proportions or factor endowment theory. The theory postulates that the difference in comparative factor endowment and prices is the key reason behind the difference in comparative product prices between two countries.

Factor Endowments

Factor endowment can be explained as the ratio of capital to labour (K/L). If the administrative centre - labour proportion in country 1 is greater than in country 2, then country 1 is said to be relatively capital-abundant (and labour-scarce) while country 2 is labour abundant (and capital scarce). Symbolically, this can be represented as

(K/L) 1 > (K/L) 2

Important implication of different factor endowments is ideal for autarky prices of factors of creation (the autarky prices are implied in the number represented below).

For two countries with same demand habits, comparative factor prices causes relative factor scarcities. Country 2 will have relatively inexpensive labour and country 1 is able to provide relatively inexpensive (numerous) capital.

Factor Intensities, Factor Great quantity and Creation Frontiers under H-O Model

Factor Intensity

Commodity Y is reported to be comparative capital intensive and item X is relatively labour extensive if the administrative centre labour ratio used in the development of Y is greater than that of the development of product X.

That is,

(K/L) y > (K/L) x

If the for the production of product Y, the united states use 2K and 2L, then K/L = 1 and if the production of product X requires 1K and 4L, K/L=1/4. In this case, it can be said that item Y is capital power and product X is labour rigorous. Factor intensity is determined by K/L as opposed to the utter amount of K and L.

At the equilibrium tips, for producing the goods, both countries choose capital-labour ration that reduce the factor costs at the prevailing relative factor prices.

The relative factor prices are symbolized as W=w/r where w is the price of labour and r is the price tag on capital. Though in principle, the factor intensities can be reversed when factor prices change. But it is assumed that does not are present in H-O model. There is no factor strength reversal.

Factor Abundance

Factor great quantity can be defined in conditions of two ways:1) Physical Items and 2) Relative Prices of factors.

In conditions of physical models, the entire amount of capital and labour available to each country is taken into consideration (that is, TK and TL). As per this definition, country 2 is capital abundant if the ratio of total amount of capital (TK) to total amount of labour available in country 2 will be higher than that in country 1. The percentage of TK/TL is important somewhat than total utter amount of K and L of the countries.

Country 2 may have less capital than country 2 and still there could be the capital abundant country if TK/TL in country 2 surpasses TK/TL in country 1.

In conditions of comparative factor prices, country 2 is capital considerable if PK/PL is lower in country 2 than in country 1. As the price of capital is taken to be the interest, r and the price tag on labour is income, w, then PK/PL= r/w. The percentage of r/w is important, not the utter degree of r or w, in determining whether a country is capital considerable or labour considerable. The first explanation calls for only the supply of factors into consideration, as the second considers both supply and demand factors.

Factor Endowments and Development Frontiers

When country 2 is capital considerable and the product Y is capital intense, country 2 can produce relatively more of item Y than in country 1. Similarly, if country 1 is labour numerous and commodity X is labour extensive, country 1 can produce relatively more of item X than country 2. This situation provides relatively flatter and wider development frontier curve for country 1 than country 2.

Diagrammatic Representation of H-O Model

The following figure signifies the Heckscher-Ohlin model diagrammatically. As it is assumed, two countries have same preferences and personal preferences for demand, both countries are symbolized in the same indifference map.

I is the best indifference curve that country 1 and country 2 can achieve independently in the absence of international trade. The details A and A/ signify equality of development and use of both countries in the absence of trade. The tangency factors of A and A/ determine the no-trade equilibrium prices of PA and PA/ in country 1 and country 2 respectively.

When PA < PA/, country 1 has comparative benefit in the creation of commodity X and country 2 has comparative edge in product Y.

The right part of the amount implies that country 1 specializes in commodity X and Country 2 in commodity Y when both countries entail in international trade.

Specialization proceeds at point where country 1 achieves the idea B and country 2 reaches at point B/. At these details transformation curves are tangent to the common relative price type of PB.

Country 1 exports commodity X in exchange for product Y and uses at point E on the second indifference curve (IC II). Similarly, country 2 exports commodity Y in exchange for commodity X and the relative equilibrium point of country 2 is point E/ which coincides with point E.

In this framework, it is important to notice that country 1's exports of product X similar country 2's imports of commodity X (that is, BC=C/B/). Likewise, country 2's exports of commodity Y similar country 1's imports of commodity Y (that is, B/C/= CE).

When PX/PY>PB, country 1 wishes to export more of product X than country 2 is able to import as of this high comparative price, and PX/PY tends to reduce to PB, which is equilibrium and normal price. Moreover, when PX/PY< PB, country 1 is able to export less of item X than country 2 desires to import at this low relative price and little by little, PX/PY tends to surge towards PB.

At point E, more of commodity Y and less of product X than at the point A are involved. However, country 1 will gain from international trade because E lays on higher indifference curve (IC II). In the same way, though at E/ more commodity of X and less commodity of Y are participating set alongside the point of A/, country 2 gains from the trade because E/ lies on higher indifference curve, IC II.

Prepositions of H-O theorem and other empirical Studies

As a connotation of H-O theorem, three other prepositions or theorems are associated

Factor price equalization theorem 2) Stopler-Samuelson theorem and 3) the Rybcsynski Theorem (Jone 2002).

The Factor Price Equalization Theorem

Even though the national frontiers eliminate the international flexibility of factors, free trade in goods leads to decrease the disparities in demand relative to supply of factor and so to diminish the disparities in factor comes back among different countries. International free trade leads to sharing of same technology by different countries and bringing of equality of factor comes back if the factor endowments are similar and sufficient level of goods are produced commonly (Samuelson 1992).

The Stolper- Samuelson Theorem

Changes in comparative product prices as brought by free international trade have strong results on the factor prices or rewards. If there is no joint creation, some factors may increase their rewards uncontrollably and other rewards may be lowered unambiguously. If the amount of factors equals the amount of commodities and production is non-joint, the comparative changes in product prices will raise the price of any particular factor (Uekawa, 1971).

The Rybczynski Theorem

If there is certainly unbalanced expansion in factor equipment, it could lead to stronger asymmetric changes in outputs also. If the amount of factors of creation and commodities are evenly matched and development is non-joint, this structure of asymmetry may pertain to development in a few factors of development (when there is given commodity prices) and may lead to the reduced amount of outputs.

Empirical Legitimacy and Leontief's Investigation

Leontief (1953) was the first to confront the Heckscher-Ohlin model with empirical analysis. He had developed a couple of data in the frame of input-output makes up about the U. S current economic climate and he computed the levels of labour and capital found in each industry for 1947. Also, he made use of U S trade data for the same calendar year to compute the factors of development (labour and capital) used in the development of $1 million folks exports and imports.

Table 1

Leontief Test (1953)

Export

Import

Capital ($million)

$2. 5

$3. 1

Labor (Person-years)

182

170

Capital/labour($/person)

$13, 700

$18, 200

Each column of the stand shows the quantity of labour and capital required to happen $1 million well worth of international trade (exports or imports) to USA in the year 1947.

Firstly Leontief measured the administrative centre and labour required for the exports from US. This estimation required the labour and capital found in each and every exporting industry and from the first row of the stand, it is seen that $2. 5 worthy of of capital was used to export value of $1million. For labour, 182 person-years were used to create the same exports.

Taking the ratio of labour and capital, it can be said just as the 3rd row of the stand, each labourer is working with $13, 700 well worth of capital. Turning to the import area of the calculation, there emerged an issue non-availability of data on international technology. Still Leontif were able to calculate the model let's assume that same technology folks found in imports. The estimation on imports (i. e. , $3. 1 million of capital, 170 person- years and capital-labour percentage as $18, 000) implies that capital labour proportion of imports is higher than that folks exports. But US economy is found in 1956 as capital-abundant which seems to contradict the H-O theorem. Thus the findings of Leontief had become called as "Leontief Paradox" (Learner 1995).

Under the construction of H-O theorem, many explanations have been proposed for the lifestyle of the paradox.

U S and foreign technologies aren't same unlike the assumption of H-O theorem.

The time 1947 was not usual year as World War II has just ended

As H-O model assumes, the U S had not been engaged in free trade.

Other Empirical Estimations of H-O model

By evaluating the limits of Leontief 's estimation, Bowen, Leamer and Sveikauskas (1987) approximated the H-O model by using data on a huge variety of countries. It was estimated to check on whether countries are net exporters of the factors of production (that happen to be relatively abundant) as factors of creation are indirectly embodied in the trade. Cline (1997) suggested a more generalized H-O model by firmly taking into account more and disaggregated factors of creation. It was acknowledged that factor endowments change over the period of time as the investment and technical advances arise.

Concluding Remarks

H-O theorem has been vehemently criticized on many grounds including in terms of its basic assumptions. Some empirical studies even questioned the validity of the theory. Despite of the many criticisms and drawbacks, H-O theory has its merits and contributions in the theoretical history of international trade.

By taking both product and factor prices under consideration, H-O theory provides a more and acceptable reason of international trade.

In comparative cost theory of David Ricardo, it was directed that comparative cost difference is the foundation for international trade. But H-O theorem better explains the reason why for these cost differences in terms of factor endowments. The purchase price equalization theory, a concomitant of H-O theorem comprehensively talks about the problem which is of course, superior to the previous theories of international trade.

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