CH Institute of Management &

Commerce
Indore (M. P.)
SUBJECT IB
PPT ON-

MODERN TRADE THEORY

(HECKSCHER-OHLIN THEORY)

Submitted to:
by:
PROF. MANMINDAR sir
MISHRA
PGPSM+MBA
BATCH2 (B)

Submitted
DIPTESH

ELI FILIP HECKSCHER

Famous Swedish Economist

Bertil Ohlin
1899-1979

1977 Nobel Prize

MODERN TRADE
THEORY
EXISTANCE:
RICARDOS Comparative Advantage
Haberlers Theories was not success.
REASONS:
1.

2.
3.

&

comparative advantage &comparative disadvantage in

the production of one commodity to another.
The ultimate determinants of comparative advantage
The production possibilities vary from country to
country.

MODERN TRADE THEORY

KNOWN BY- HECKSCHER-OHLIN THEORY

why countries trade goods and services between

two countries.

What determines comparative advantage?

What are the effects of international trade on

the earnings of factors of production?

HECKSCHER-OHLIN THEORY

Assumptions:
1. It is 2x2x2 model. There are 2- country (A&B), 2
commodities (Commodity X and Y), and 2 factors of
production (Capital and Labor).
2. There is no changed in technological knowledge in
production.
3. Different factor IntensiveCommodity X is labor intensive and commodity Y is capital
intensive in both nations
Commodity
X requires relatively more labor to
produce than commodity Y.
(K/L) < (K/L)
X
Y

HECKSCHER-OHLIN THEORY

Assumptions:
4. Both commodities are produced under
constant returns to scale in both countries.
5. There is incomplete specialization
production in both countries.

in

6. Tastes& preferences of consumer and the

demand patterns in both countries are
identical.

HECKSCHER-OHLIN THEORY

Assumptions:
7. There is perfect competition
commodities and factor markets
countries.

in
in

both
both

Producers and consumers are too small to affect the price

level.
Normal profit
Homogeneous products and inputs.
Perfect knowledge.

8. There is perfect factor mobility within each

nation but no international factor mobility.

HECKSCHER-OHLIN THEORY

Assumptions:
9. There are no transportation costs,
tariffs or other obstructions to the free
flow of international trade.
10. All resources are fully employed in
both countries.
11. International trade
countries is balanced.

between

two

HECKSCHER-OHLIN THEORY
12. There are quantitative difference in
the factors and govt. in different
reasons
but
qualitative
there
homogeneous.
PHYSICAL CRITERIYA Factor-Price RatioPc1
Pc2

<

PL 1

PL 2

HECKSCHER-OHLIN THEORY

Factor Intensity:
Commodity Y is capital intensive if the (K/L)
ratio used in the production Y is greater than
(K/L) used in the production of X.
Commodity X is labor intensive if the (L/K)
ratio used in the production X is smaller than
(L/K) used in the production of Y.

Factor Intensity:
S
G

oO

E
L

HECKSCHER-OHLIN THEORY

Factor Abundance:
Physical units: In terms of overall amount of capital and
labor available to each nation.

Nation 2 is capital abundant if: (KA/LA)2 > (KB/LB)1

Considers only supply

Relative factor prices: In terms of rental price of capital

and the price of labor time in each nation.

Nation 2 is capital abundant if: (PK/PL)2 < (PK/PL)1

Considers both supply and demand

HECKSCHER-OHLIN THEORY

Heckscher-Ohlin 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.

HECKSCHER-OHLIN THEORY

According to this theory:

Nation2 exports commoditay Y because
commodity Y is the K-intensive commodity and
K is the relatively abundant and cheap factor in
Nation 2.
Nation 1 exports commodity X because
commodity X is the L-intensive commodity and
L is the relatively abundant and cheap factor in
Nation 1.

GENERAL EQUILIBRIUM WITH TRADE

P
C
G
A

y
E

QI - ---------------

oO

D
X

CONCLUSION

Y = HG = JE
X= JF = HE
H-O suggests that each nation will
have a comparative advantage in the
goods that intensively use its
abundant factors. With free trade,
each nation will specialize in and
exports its comparative advantage
goods.

Criticism Of The Heckscher - Ohlin

Theory
Nations do not initiate trade: this is done by
individuals or individual firms within nations.
There must be perfect information and perfect
competition between trading partners, which is
never the case.
They are limited because they do not look at
either the transfer of goods or direct investments.
They do not recognize the influence of technology
and expertise in the areas of marketing and
management.