Introduction

Eli Heckscher (1919) and Bertil Ohlin (1933) found the basis for crucial and substantial theoretical developments of international trade by emphasizing the relationships between the composition of countries’ factor endowments and commodity trade patterns. The Heckscher-Ohlin (H-O) theory is the simplest explanation for why countries involve in trade of goods and services with other countries. Heckscher-Ohlin model, which is the general equilibrium mathematical model of international trade theory, is built on the Ricardian theory of comparative advantage by making prediction on trade patterns and production of goods based on the factor endowments of nations (Learner 1995).

Assumptions of the Heckscher-Ohlin Model

The following 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 production (capital and labour).
• For producing the goods, both nations use the same technology and they use uniform factors of production.
• In both countries, good X is labour intensive and Y is capital intensive.
• The tastes and preferences of both nations are the same (both countries can be represented in the same indifference curve).
• In both nations, the assumption of constant returns to scale is applicable for the production of goods X and Y.
• In both nations, specialization in production is not complete.
• Goods and factor markets in both nations are perfectly competitive.
• There exists perfect mobility of factors of production within each country though international mobility is not possible.
• There are no restrictions or limitations to the free flow of international trade. That is, there exist no transportation costs, tariffs, or like other obstructions either to control or to restrict the exports or imports.
• It is assumed that there exists full employment of all resources in both nations. That is, there will not be any under employed resource in either nation.
• The exports and imports between the nations are balanced. It means that the total value of the exports will be equal to the total value of imports in both nations.

Home

Implications of the Assumptions

The assumptions are made in order to depict the theory in a two-dimensional figure. It is also implied that both countries have access to and use the same general production techniques. The labour-capital ratio (L/K) of commodity X is higher than that of Y in both countries with the same relative prices of factors. As constant returns to scale is assumed, increase in the amount of labour and capital will result in the proportionate increase in the output also. Another implication is that though free international trade exists, both of the countries produce both commodities and it can be presumed that both countries are not small in size.

As the tastes and preferences related to demand are identical in both countries, if the relative prices of the goods are equal, the consumption of goods X and Y will be in the same proportion in both countries. Likewise, in both countries producers, traders and consumers are too small to affect the commodity prices. Mobility of factors of production implies that capital and labour are free to move from areas or industries of lower prices (earnings) to those of higher prices (earnings) until earnings become same equal 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 absence of international trade.

The assumption of incomplete production specialization implies that the process of specialization in production continues until the commodity prices (either relative or absolute) prices are the same in both countries. Again, if the transportation costs, tariffs or any other restriction are allowed, specialization will continue only until price differences by less than or equal to the costs or tariffs.

The Heckscher-Ohlin Model

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

Definition: A nation exports the commoditie