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FACTOR ENDOWMENT THEORY The factor endowment theory was developed by Swedish economist Eli Heckscher and his

student Bertil Ohlin. This theory consists of two important theorems, namely, the Heckscher-Ohlin theorem and the factor price e uilisation theorem. The Heckscher-Ohlin theorem e!amines the reasons for comparative cost differences in production and states that a country has comparative advanta"e in the production of that commodity which uses more intensively the country#s more abundant factor. The factor price e uali$ation theorem e!amines the effect or international trade on factor prices and states that free international trade e uali$es factor prices between countries, relatively and absolutely, and thus serves as a substitute for international factor mobility. Heckscher-Ohlin Theorem Heckscher and Ohlin have e!plained the basis of international trade in terms of factor endowments. The classical theory demonstrated that the basis of international trade was comparative cost difference. However it made little attempt to e!plain the causes of such comparative cost difference attempts to e!plain why comparative cost differences e!ist internationally. They attribute international differences in comparative costs to% &. 'ifferent prevailin" endowments of the factors of production, and (. The fact that production of various commodities re uires that the factors of production be used with different de"rees of intensity. )n short, it is the difference in factor intensities in the production functions of "ood alon" with actual differences in relative factor endowments of the countries which e!plains international differences is comparative cost of production. )n the Heckcher-Ohlin model, factors of production are re"arded as scarce or abundant in relative terms and not in absolute terms. That is one factor is re"arded as scare or abundant in relation to the uantum of other factors. Hence, it is uite possible that even if a country has more capital, in absolute terms, than other countries, it could be poor in capital. * country can be re"arded as richly endowed with capital only if the ratio of capital to other factors is hi"her when compared to other countries.

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)n -ountry *% Supply of labour Supply of capital -apital-labour ratio . (/ units . (0 units . 0.1 . &( units . &/ units . &.(/

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)n country B% Supply of labour Supply of capital -apital-labour ratio

)n the above e!ample, even thou"h -ountry * has more capital in absolute terms, -ountry B is more richly endowed with capital because the ratio of capital to labour in -ountry * +0.1, is less than in -ountry B +&.(/,. *ssumptions a. b. c. d. e. f. ". h. i. Both product and factor markets in both countries are characteri$ed by perfect competition. 2actors of production are perfectly mobile within each country but immobile between countries. 2actors of production are of identical uality in both countries. 2actor supplies in each country are fi!ed. 2actors of production are fully employed in both the countries. 2actor endowments of one country vary from that of the other. There is free trade between the countries, i.e., there are no artificial barriers to trade. )nternational trade is costless, i.e., there is no transport cost. Techni ues of producin" identical "oods are the same in both countries. 'ue to this, the same input mi! will "ive the same uantity and uality of output in the countries. 3. 2actor intensity varies between "oods. 2or instance, some "oods are capital intensive +i.e., they re uire relatively more capital for their production, and some others are labour intensive +i.e., they re uire relatively more labour for their production,. k. 4roduction is sub3ect to the law of constant returns, i.e., the input-output ratio will remain constant irrespective of the scale of operation.

Factor Price Equalisation Theorem The factor price e uali$ation theorem states that free international trade e uali$es factor prices&/ between countries, relatively and absolutely, and this serves as a substitute for international factor mobility. The international trade increases the demand for abundant factors +leadin" to an increase in their prices, and decreases the demand for scarce factors +leadin" to a fall in their prices, because when nations trade, speciali$ation takes place on the basis of factor endowments. *ccordin" to Ohlin, 5The effect of inter-re"ional trade is to e uali$e commodity prices. 2urthermore, there is also a tendency towards e uali$ation of the prices of factors of production. The followin" fi"ure shows the production decisions based on factor endowment by Heckscher-Ohlin theorem in different countries.

Merits o Heckscher-Ohlin Theor!" The Heckscher 6 Ohlin theory has certain definite merits. &. The Heckscher6Ohlin theory ri"htly points out that the immediate basis of international trade is the difference in the final price of a commodity between countries, althou"h the actual basis or ultimate cause of trade is comparative cost difference in production. Thus, the Heckscher-Ohlin theory provides a more comprehensive and satisfactory e!planation for the e!istence of international trade. (. *lthou"h the 7icardian theory points out that comparative cost difference is the basis of international trade, it does not e!plain the reasons for the

e!istence of comparative cost differences between countries. The HeckcherOhlin theory e!plains the reasons for the differences in the cost of production in terms of differences in factor endowments. This is another aspect that makes it superior to the 7icardian analysis. 8. The classical theory implicitly assumes that international trade will come to an end if the labour cost of production of commodities become e ual every where, whereas the Heckscher-Ohlin become e ual every where because of the differences in the factor endowments. 9. :hile the classical theory is based on comparative differences in the labour costs of production of commodities between countries, the Heckscher-ohlin theory is more realistic as it considers the differences in the production function 6 production cost and price. E ects o #nternational Tra$e The Heckscher-Ohlin theory indicates that international trade will ultimately have the followin" results% &. E ualisation of -ommodity 4rices (. E ualisation of 2actor 4rices Em%irical o H-O Mo$el Some notable attempts have been made to empirically test the validity of the Heckscher-Ohlin ;odel. * brief account of some of them are "iven below% &eontie Para$o' The credit for makin" the first comprehensive and detailed verification of the Heckscher-Ohlin theory "oes to :assily :. <eontief. The =nited States of *merica was believed to be a country with abundant capital endowment and scarce labour endowment. Then, if the factor proportions theory were correct, the =S should have been e!portin" capital intensive commodities and importin" labour intensive commodities. However, the result of <eontief#s test disproved this hypothesis. This parado!ical result of test, that showed that the =nited States was actually e!portin" labour intensive "oods and importin" capital intensive "oods, came to be popularly known as the <eontief 4arado!.

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