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Title: Chapter IV neo-classical model of international trade theory: Heckscher - Ohlin Model

1
Chapter IV neo-classical model of international
trade theory Heckscher - Ohlin Model

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2
Section 1 Heckscher and Ohlin's main contribution
to their trade ideas

In the neo-classical international trade theory,
the contribution is most critical to Heckscher
and Ohlin.
By Adam Smith and David Ricardo, represented by
the classical economists point to the labor
theory of value based on demonstrated national
differences in labor productivity, thus built up
a theory of comparative advantage.

Heckscher and Ohlin's contribution is to
establish a Heckscher - Ohlin model (ie H-O
model) extends the model of comparative
advantage.
Firstly, differences in factor endowments
explains the basis of international trade.

Secondly, Adam Smith and David Ricardo's
international trade theory was questioned.
After 1890, Marshall's equilibrium price theory
has replaced the labor theory of value as the
basis of Western economics, but the labor theory
of value is still the dominant theory of
international trade.

Ohlin factor endowment theory of production is to
meet this "reform" of the need to put forward.
Ohlin put the Ricardo's comparative cost
integrated the theory of John Stuart Mill's
theory of mutual needs, Marshall's equilibrium
price theory and the theory of comparative costs
of Taussig, based on his teacher Heckschers
(1879 1952) encouragement he created the
production factor endowment theory, it is also
known as Heckscher - Ohlin theorem. Ohlin
therefore won the Nobel Prize in Economics in
1977.

In the H-O Model, Ohlin thought that the first
condition of trade is the price differences
between regions. This price difference from the
demand perspective, the desire by consumers and
the ownership of factors of production (which
affect the consumer's income) to decide from the
supply perspective, from all over the size of the
production factors of production.

In many places the same preference for the
consumption of goods, demand conditions remain
unchanged and the same level throughout the
production technology, under the assumption of
constant returns to scale ,Ohlin thought that
'sufficient' condition of the regional trade is
the unequal endowment of factors of production.

Since each region contains a large proportion of
exports is relatively abundant and inexpensive
elements, and thus these elements have become a
scarce than before. While imports contains a high
proportion of scarce elements, and thus these
elements become less scarce over. Therefore, the
consequences of regional trade is to make
commodity price equalization, the prices of
factors of production are also the trend towards
equalization.

Factor endowment theory has opened up the
beginning of modern international trade theory,
and later on the theory of factor endowments a
lot of economists developed and validated
.Fanally, the Leontief paradox and Rindel demand
similarity theory appeared.

10
Section 2 Heckscher - Ohlin factor endowment
trade model

1, H-O model assumptions2, factor intensity and
factor abundance3, H-O model analysis4, For the
analysis of theoretical significance for H-O model

11
I?H-O model assumptions

there are 11 assumptions about H-O model, the
most important are the following six, when we
gradually relax these assumptions, we will get
different conclusions.

1, the two countries, two products, two factors
of production.2, factors of production in the
world countries are homogeneous and, in all
countries the supply of factors of production is
fixed .But in the domestic inter-industry flows
can be.

3, on the assumption that the production function
has three aspects
Production function is linear, and for the
constant returns to scale the marginal
productivity of factors of production is
positive, but decreasing.

The same production between countries has the
same function, there is no technology gap.
There is no factor intensity reversal ,that is,
different products were produced with different
elements of production, elements of the same
product portfolio is always the same.

4, the demand pattern of two kinds of product
between two countries is the same and the ratio
depends on the prices of various commodities
consumption rather than income, that income level
and preferences do not determine the type of
trade (pattern of trade).

5, there is not fully professional division of
labor, assuming that under the free trade between
the two countries produce two products.
6, there is no transport costs and trade
barriers, commodity and factor markets are
perfectly competitive.

17
II? factor endowments and relative supply

(A) factor intensity and factor abundance
Factor intensity refers to the production of one
unit of a product used a combination of factors
of production ratio. Under the circumstances of
two kinds of capital and labor factors of
production, the intensity factor of production
refers to a unit of the product used in the
capital - labor ratio.

Factor intensity is a relative concept, even if
the production of two kinds of products, the
number of different elements of the various
inputs, but as long as the input to the relative
ratio of the various elements of the same, then
this factor intensity of both products is the
same.

Elements of the two products and the proportion
of the relationship between factor prices can be
comparable, corresponding to a certain price
level, the relative factor intensity also can
determine.

Suppose X and Y two kinds of commodities in the
production process required for the proportion of
factor inputs (capital / labor) were KX / LX and
the KY / LY. If the KY / LYgt KX / LX, claimed
that Y is capital-intensive products, X is
labor-intensive products.

Factor abundance is a measure of a country owned
by the relative abundance of economic resources,
or resources of a country relative supply.

There are two methods of the definition of
abundance. One is based on the definition of
physical units, and the other is based on the
definition of relative factor prices.

The first method If the country B the total
capital available and the availability of the
ratio of total labor force (TK / TL) is greater
than the proportion of A in this country, we say
B is a capital abundant country. Note that this
method using a total capital and the ratio of
total labor force, rather than the absolute
number of both. If the B State TK / TL is greater
than A country's TK / TL, even if country B's
capital has a less than A country, B is still the
capital abundant country.

The second method If the country B the price of
capital and labor time, the ratio of prices of
the country this ratio is less than A, we say B
is a capital abundant country. Similarly, should
pay attention to decide whether a country is
capital abundant, not to see the price of capital
(eg, r) the absolute level, but to see it with
the price of labor (eg w) ratio of r / w size.
For example, B States, r may be higher than the
country A, but if the country B r / w is less
than A State r / w, then B is the capital
abundant country.

(B) differences in factor endowments and relative
differences between the supply Abundant factor
will affect the production possibilities curve
shape. As shown below

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If the labor abundant country A and X as a
labor-intensive products, B and Y-abundant
countries to capital-intensive products, then, A
State AA production possibilities curve will be
relatively biased towards X-axis, B-country
production possibilities curve will be relatively
biased towards BB Y-axis.

28
III?H-O model analysis

(A) general equilibrium analysisThe use of
analytical tools production possibility curve
and the social indifference curve.
Compared with the classical trade model, HO model
is the assumption that a country's production
possibilities there are two differences

Firstly, on the production of various commodities
between the two countries the ability for
different reasons. The classical trade model to
explain the different technologies for the
production, while the H-O model emphasizes
different elements of the endowment.

Secondly, on the assumption that the opportunity
cost of production. The classical trade model
assumes that labor is the only inputs, labor
input per unit of output remains unchanged.
Therefore, the opportunity cost per unit is
fixed, production possibilities curve is a
straight line.

But the H-O model assumes that there are two
kinds of factor inputs, the opportunity cost of
production is increasing. That is, when a
country's productive resources of its transfer of
production from one product to another production
of a product, had to give up the number of
products will keep rising. The opportunity cost
of increasing production possibility curve will
have a convex shape.

32
Figure, assuming that country A is
labor-intensive, country B is
capital-intensive, the two countries as shown in
Figure PPF line.The same social indifference
curve between the two countries.
33

The common indifference curve I0 with A country's
PPF is tangent at P1, with B country's PPF is
tangent at P2, the respective tangent,
respectively a and ß (indicated with their
respective domestic exchange rate between the two
countries).

The slope a is less than ß, the trade-abundant
elements of the former labor-intensive product X
in country A is relatively lower prices, that is,
Y can be less for a larger number of X in the
capital element of the country while the capital
adequacy of the B Y-intensive products relative
lower prices, less X-can be exchanged for larger
Y.

After trade, the two exchange rate is r, the
equilibrium point of trade is at R, namely r and
I1 tangent at R. r also with PPF between the two
countries respectively, tangent in Q1, Q2,
therefore, A country will produce two kinds of
commodities Q1 point, in the R-point consume two
commodities.

X-products, A countrys production is greater
than consumption, exports T1Q1 X-goods the Y
goods, A is greater than consumption, the country
production, import T1R Y-goods. Similarly, B
country's export T2Q2 Y-goods imports T2R
X-products.

H-O Theorem a country must export the intensive
use of the country's relatively abundant and
cheap factor and import of goods intensive use of
the country's relatively scarce and expensive
element of the goods.

In other words, labor abundant countries should
export labor-intensive-based products, import
capital-intensive products type of capital
abundant countries should export
capital-intensive products and import
labor-intensive products.

In all that may result in differences in the
relative commodity prices and comparative
advantage between countries, H-O theorem that the
countries in relative factor abundance that
factor endowments (factor endowments) is an
international trade, countries have a comparative
advantage in the underlying causes and
determinants. It is for this reason, H-O theorem
also often referred to as factor endowment
theory.

Under the common price ratio, the trade volume
between the two countries are equal, that is,
T1Q1 T1R T2R T2Q2, that is, bilateral trade
triangle RT1Q1 and RT2Q2 are the same. But the
level of consumption between the two countries
have moved to a higher level of utility I1,
showed that The two countries have been trading
interests, but in this case equal to the trade
interests of the two countries.

(B) partial equilibrium analysis1. The formation
of individual commodity prices on international
market
In accordance with their production possibilities
curve and the social indifference curve, you can
derive some sort of commodity supply curve
between the two countries and the demand curve
and its domestic market equilibrium price.

2. The impact of trade on producers and consumers
The impact of trade on consumers depends on the
difference that between the consumers are willing
to pay the price of a commodity and its actual
price paid after trade .That is consumer surplus
.Concluded that consumer surplus had increased
through trade.

The impact of trade on producers depends on the
difference between the transaction price and its
opportunity cost of goods produced by the
producer that is the amount expressed in producer
surplus. Producer surplus may be positive, may
also be negative.

For the whole of social welfare, consumer surplus
and producer surplus depends on the size of their
own, if there is an average of two-phase
remaining, it shows the international trade will
bring about a net of social welfare.

3. Terms of tradeIn economics, the ratio of
export price (PX) in international market and
price of imported goods (PM) in international
market is called the country's terms of trade
(referred to as TOT).Terms of trade (TOT) PX /
PM

When international trade transactions are more
than two commodities, the import and export
prices should be calculated using the weighted
method, as followsPX SXiPiPM SMipi

If the PX / PM ratio increased, which means you
can exchange for more imported goods with per
unit exported goods, this situation is improved
terms of trade and vice versa, for the
deteriorating terms of trade.

48
IV? The analysis of theoretical significance of
H-O model

Compared with the classical trade theory, H-O
model's main contribution is reflected in the
following two aspects
1. Analyzed the production costs within the
framework of the two or more factors of
production.

2. Analyzed the mutual impact between the changes
of factors and international trade using the
method of general equilibrium.

50
Section3 factor price equalization and income
distribution

First, factor price equalization theorem
Second, trade short-term impact on income
distribution a specific factor model
Third, trade, long-term impact on income
distribution Stolper - Samuelson theorem

1, factor equalization theorem
(A) the meaning of the factor price equalization
theorem

Even if the international mobility of factors of
production do not have the condition, as long as
the full development of free trade of goods, then
the countries with the kinds of factors of
production relative prices will tend to equal
At the same time, the absolute prices will tend
to equal In other words, international trade
would pay the same, but also make the same
national interest. Since this proposition is
extended H-O model, it is also known as the H-O-S
model.

Under free trade conditions, a country will
expand production that using its abundant factor
intensively ,reducing production that using its
scarce factors intensively , so that increased
demand for abundant factors, reduced demand for
scarce factors, in terms of price, the price of
the previous cheaper abundant elements would
rise, the high prices of scarcity of the original
elements will be lowered because of reduced
demand. At the same time, the opposite occurred
in another country .Thatis situation is why the
two countries the price of labor and capital
ratios will tend to equal, namely, factor price
equalization theorem.

54
Nation 1 is Labor abundant X is L-intensive
commodity, X is with comparative advantage.
Nation 2 is capital abundant , Y is K-intensive
commodity, Y is with comparative advantage.
The relative price of capital (interest rate) is
lower and the relative price of labor is higher
The relative price of labor (wage rate) is lower
Specializes in the production of commodity X
Specializes in the production of commodity
Y,reduces production of X (L-intensive)
The relative demand for labor rises
The relative demand for labor falls
Price of labor (wage) rises
Price of labor (wage) falls
55

(B) The evaluation of the factor price
equalization theorem
Firstly, it demonstrated that all differences in
factor prices, as well as factors of production
can not be the international free flow and can
not make a optimal allocation of resources,
international trade as a substitute for
international mobility factor can be indirectly
achieved the best resources around the world
configuration, and ultimately the factor price
equalization.

Secondly, it illustrates the internal allocation
of trade interests, that shows how international
trade affect the income distribution pattern of
trading nations.

In the H-O model, we assume that there are only
two factors two products, product categories and
factors is the same. However, if the factor
types rather than products (industries) type, for
example, three kinds of factors and two kinds of
products, how did trade affect the production
and income distribution?

Three factors two products model is "a specific
factor model", assuming that certain factors are
specific to certain industries, these factors can
not flowed in the industry.

Specific factor model can be seen as H-O model
that some elements can not be free flow in the
short-term .

60
2. short-term impact of trade on income
distribution a specific factor model

The basic framework of a specific factor model
In this model, we assume that there are two kinds
of products rice and steel. However, there are
three factors of production inputs labor,
capital and land, respectively L, K, T, said.

In which specific factors are capital and land,
and capital only for steel production, the land
only for food production, labor is a public
factor or common factor, in the two products are
used in production. As capital and land is
limited to specific products, will not flow
between departments, while the labor is used in
elements of both departments, you can move freely
between different departments, therefore, labor
is also known as "mobile elements."

We also assume that the various elements to
achieve full employment, capital and land are all
were used in the production of steel and rice,
while the labor resources of two departments
equal to the total (L) that Lr Ls L, where
Lr is the labor for the production of rice, Ls is
the labor used to produce steel.

Under the assumption of full employment of
factors, for the production of rice land for the
production of iron and steel inputs and capital
inputs are fixed, respectively, equal to the
total amount of these two specific elements.
Labor allocation between the two departments,
whether the department with much more, which
sectors are used as little uncertain. Therefore,
the two products were determined on the
production function as
Qrf(T,Lr)
Qsf(K,Ls)

If Specific elements (T and K) unchanged, rice
and steel production are the production function
of labor input.

MPL
Qrf(T,Lr)
L
65

Since labor is the public element of the free
movement between the two departments. How labor
allocation between the two sectors, depending on
the labor market supply and demand. The following
figure shows two departments of labor demand and
aggregate supply of labor. Under the assumption
of perfect competition and full employment that
the market equilibrium wage, the national labor
supply is equal to the total of labor in rice
production and steel production .

The labor demand of every department is decided
by the marginal productivity of labor and product
price. In the profit maximization, firms pay
wages will not exceed the value of labor is
created there. Therefore, firms demand for labor
(wages firms are willing to pay) is equal to
price (P) multiplied by the marginal product of
labor input quantity produced (the marginal
productivity of labor, MPL). According to the law
of diminishing marginal output, in other factor
inputs unchanged, firms hire more labor, marginal
product of labor less. Therefore, for any given
product prices, labor demand is a downward curve.

67
W
W
Steel industry
Rice industry
W
W
Lr
Ls
68

In the picture above, the left is the labor
demand curve of rice production sector , equal to
the price of rice multiplied by the marginal
output of labor in rice production. The right is
the labor demand curve of steel production
sector, equal to the price of steel multiplied by
the marginal production of labor iron and steel
output.

Lower wages, the two departments need more labor.
When the wage is equal to W , the two
departments of labor employed is equal to the
total labor supply, labor market equilibrium, and
determine the allocation of labor in the two
sectors, but also determines the yield of the two
departments.

70
Factor prices

Prices of factors of production depends on the
value of marginal product of factors. Two
elements in the economy, the price of labor (wage
rate) is equal to the marginal product of labor
and product prices, namely

w VMPL MPL PCapital price (interest rate)
is equal to the marginal product of capital and
price of the product, namelyi VMPK MPK
PVMPL and VMPK respectively, the marginal
product of labor and capital value.

In the production process, on the one hand, if
the amount of capital investment remain
unchanged, with the increase of labor input,
product output increased, but the diminishing
marginal product. At this point, if the price
fixed, the value of marginal product of labor to
reduce the wage rate has dropped. On the other
hand, for a certain amount of labor input, if the
product price changes, wage rates also come down.

73
Application of a specific factor model

The impact on International Trade
According to the definition of the labor demand
curve, we know that an industry's product prices
or changes in the marginal productivity of labor
will cause the industry demand curve up and down.
An industry's labor demand curve upward, said
manufacturers in the industry are willing to pay
higher wages.

In the following specific factors model, the
labor demand curve of the rice production sector
upward and the number of employment change, then
the rice production sector wages could rise to a
W2. However, as labor can move freely between
sectors. A part of labor in the steel industry
flow to the rice industry, the wage increase rate
of the rice industry is not W2 but W1.

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OO ' country A total labor supply, from the O to
the right measured labor input of X industry,
from O' to the left measured labor input of Y
industry. Left and right vertical axis measure X,
Y industry wage rate.

In a closed economy, the value of marginal
product of labor curve of X industry VMPLX and
the value of marginal product of labor curve of
the Y industry VMPLY intersect at E0, E0 is a
equilibrium point. The amount of labor employed
in X industry is OL0, the amount of labor
employed by Y industry is O'L0, elements of
competition between the two industries work to
ensure access to the same wage rate W0.

In an open economy, international trade let
country A exports X, price increases, price
increases set E0C, VMPLX curve upward to VMPLX '.
To simplify, assume that the price of commodity
Y remain unchanged, then X industry exists to W2
wage rates rise. Free mobility of labor, wage
differences among industries will drive labor
flow from the Y industry to the X, the end point
of equilibrium in the E1, the number of labor
from the Y for the L0L1 into the X, the two
industries together wage rate increased to W1.

Considering the import and export can draw the
following conclusions With the free trade ,
export industry to improve return of fixed
factors, and improve the real income the returns
of fixed elements of import-competing industries
will fall, real income deteriorate mobile factor
income changes uncertain, depending on
international exchange price, the slope of the
marginal product value, and element suppliers of
consumer preferences.

80
3. Long-term impact on income distribution
Stolper - Samuelson Theorem

In the long term, all factors of production can
flow between the various sectors, including the
capital. As free competition in the industry the
production will make further adjustment. Before a
new equilibrium point is reached the export
sector will continue to expand the production,
the production of import industry will be further
reduced. The factors of production used in
industry capacity will continue to change.

Earlier in the discussion when the factor price
and commodity price mentioned, a rise of a factor
price relative to other elements will lead to a
"smaller scale" rise of the relative prices of
goods that produced by the factors intensively
used. Now conversely, the relative prices of a
commodity, will accordingly let the return of
factors of production intensively used increase
,but other decline. This is the basic meaning of
Stolper - Samuelson theorem .

Assume that there are two countries A and B
,country A land (on behalf of capital)
abundant, exported wheat, imported textiles
country B labor abundant, exported textile,
imported wheat.
Now, let us focus on country A, and further
assume that the proportion of factor inputs of
two products in country A (labor / capital) for
30 / 2 (wheat) and 50 / 1 (cloth).

After trading, if the relative price of wheat
rose, while the relative price of cloth decline
,then producers of country A will reduce the
production of cloth, to shift resources to wheat
production. But it may be noted, the proportion
of factors of two products in country A is
different, so the rate of production factors that
additional factors of production needed for the
production of wheat and vacated factors as
stopping the production of cloth is different,
each additional 100 units of production of wheat
must use additional unit of land and give up 20
units labor.

Also assume that a country's resource supply is
limited, so there is a contradiction between
supply and demand in the market of factors of
production land prices increased due to
increased demand, for labor prices went down due
reduced demand, that is that the returns of land
increased, labor factor reward reduced. the
situation of country B is contrary.

This shows that the changes of relative prices
of commodities will affect the changes of factor
price and the changes of factors return. From the
above example, the returns of factors intensively
used in the export industry increased.

According to H-O model, the factors of production
intensively used on export goods is its abundant
factor, so the rise in the relative price of
exports will lead to the rise of the real price
of abundant factors, while actual price of the
scarce factor or return will decline.

87
Section IV Empirical Test to the Heckscher -
Ohlin trade model of resource endowment

1.The background and content of Leontief
2. various interpretations of Leontief paradox

88
1.The background and content of Leontief

The first experience test to H-O model made by
Leontief in 1951 and used the data of the United
States in 1947. Because the United States was the
world's most capital-abundant countries, Leontief
expect to conclude that U.S. exported
capital-intensive goods and imported
labor-intensive goods.

He estimated the capital / labor ratio of import
substitution not imports of the U.S. However,
Leontief still properly drawn the following
conclusions If the H-O theory is true, even
though the capital-intensity of the U.S. import
substitutes were more than its real imports
(because the capital of the U.S. is relatively
cheap than other countries), but its intensity
remains less than U.S. exports.

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Leontief's calculations gave himself and others a
confusing paradox" the United States actually
exported labor-intensive products and imported
capital-intensive products in 1947. The key rate
(KX / LX) / (KM / LM) is 0.77, and according to
H-O theory, the ratio should be greater than 1.
The contradiction between reality and theory is
the famous "Leontief mystery."

92
2. various interpretations of Leontief paradox

(A) Due to the higher efficiency of American
workers
Leontief thought that in 1947, the labor
productivity of American workers was three times
higher than that of foreign workers, if we
multiplied the number of U.S. labor by 3, we
would find the United States was actually a labor
abundant country. But this is true only in the
United States the labor-intensity of exports is
higher than imports. This explanation was not
widely accepted, Leontief himself denied it
later.

(B) due to richer human capital of the U.S.
The most important reason of this contradiction
can be that the capital defined by Leontief
includes physical capital only, while completely
ignoring the human capital. Human capital is
owned by the workers to improve their labor
productivity such as education, training, health
work etc. This implies that the labor of the
United States included more human capital than
other countries, the human capital added physical
capital will enable the capital-intensity of
exports of the United States higher than imports.

(C) due to the state of natural resources of the
U.S.
Another more general bias due to Leontief using
two factors (labor, capital) model, and ignored
other factors such as natural resources (land,
minerals, forests, etc.) influence. If a
commodity is a natural resource type in the
two-factor model ,then it is clearly not correct
to divide it into capital or labor-intensive
goods. In addition, many production processes
require the use of natural resources, such as
mining, steel industry, agriculture, etc., also
need a lot of physical capital. The United States
depends heavily on imports of many natural
resources, which may help explain the higher
capital-intensity of the U.S. import
substitution industry.

(D) caused by the production factor intensity
reversal
(E) due to the U.S. trade policy
U.S. tariff policy is also important reason for
Leontief paradox. Customs duty on imports in
fact, it reduces imports and stimulate domestic
production of import substitutes. Kravis found
that in 1954, the most stringent industry by the
trade protection in the United States is
labor-intensive industries. This has affected the
U.S. trade patterns, reducing U.S. imports of
labor-intensive. This helped to explain the
Leontief paradox.

(6) caused by the demand reversal
In the H-O model, we assume that consumer
preferences between the two countries are
identical and, therefore, international trade
pattern depends only on difference of natural
resources endowment , but not demand. But the
decided factors of international trade may come
from supply-side and also come from the demand
side.

There are numerous ways that demand factors
affected international trade, for example, when a
country have a comparative advantage on a product
production , and its people have a special
preferences on this product, it will make the
relative price of products rise, so the direction
of import and export determined by H-O model
originally will change , that means demand
reversal.

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