LESSON 4

• Heckscher-Ohlin Model:

  • Developed by Swedish economists Eli Heckscher and Bertil Ohlin in the 1920s
  • Also known as the factor proportions model, a 2-by-2-by-2 variant (2 goods, 2 factors, 2 countries)
  • Assumes that labor and capital are used to produce two final goods
  • The model allows for variation in factor proportions across and within industries
• Capital-labor ratio:

  • The ratio of the quantity of capital to the quantity of labor in a production process
  • Different industries producing different goods have different capital-labor ratios
• Industry characteristics:

  • In a model where a country produces two goods, an assumption is made about which industry has the larger capital-labor ratio
  • Example: If steel production uses more capital per unit of labor than clothing production, steel production is capital-intensive relative to clothing production
• Heckscher-Ohlin Model implications:

  • Shows how changes in supply and demand in one market can lead to factors and national markets
  • Demonstrates interactions across factor markets, goods markets, and national markets simultaneously
• Four main theorems in the Heckscher-Ohlin Model:

  • Heckscher-Ohlin Theorem predicts trade patterns based on countries' characteristics
  • Stolper-Samuelson Theorem describes the relationship between changes in prices of goods and factor prices
  • Factor-Price Equalization Theorem states that as countries move to free trade, factor prices will be equalized
  • Rybczynski Theorem shows the correlation between changes in national factor endowments and outputs of final goods
• Aggregate economic efficiency:

  • Heckscher-Ohlin model demonstrates increased aggregate efficiency in free trade
  • Price changes lead to changes in production of goods in both countries