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Economics Assingment New
Economics Assingment New
Economics Assingment New
SUBMITTED TO:
SIR HARI CHAND THAKUR
SUBMITTED BY:
NAVISHA VERMA
B.A.LLB(HONS.)
3rd SEMESTER
ROLL NUMBER: 1020181960
Academic Year 2018-2019
ACKNOWLEDGMENT
Every project big or small is successful largely due to the effort of many people who have
always helped from behind for every successful work. This project has been completed not
only by my efforts but several others who have timely helped me at every step I moved
forward. I would like to thank my module tutor Dr. Ved Prakash for giving this opportunity
to work on such an enlightening topic. I would also like to thank my family and friends for
providing me with full support, help and motivation at the time when I needed it the most.
I would also like to thank all the faculty members of H.P. NATIONAL LAW
UNIVERSITY (SHIMLA), for their critical advice and guidance without which this project
would not have been possible.
Contents
INTRODUCTION......................................................................................................................4
ASSUMPTIONS OF THE HECKSHER-OHLIN THEORY....................................................5
CRITICISM................................................................................................................................9
INTRODUCTION
The structure of the modern theory of international trade rests fundamentally upon the theory
developed by Eli Heckscher and Berlin Ohlin. This theory has almost completely replaced the
classical and non-classical theories related to international trade. But it does not mean that
there is some real conflict between the Hecksher-Ohlin approach and the comparative costs
approach or that the former in any way, invalidates the latter. In fact, the Hecksher-Ohlin
approach in a powerful manner. it goes behind the comparative costs doctrine to investigate
the basic the cause of the relative differences in costs. Hecksher and Ohlin have traced the
cause of cost differences to relative factor endowments and relative factor intensities. That is
why theory is also known as Proportions-Factor-Intensity Theory. According to this theory,
countries which are rich in labour-intensive goods and those rich in capital will export
capital-intensive goods.
FACTOR ENDOWMENTS
It is incontrovertible fact that regions or countries differ from one another in respect of
endowments or availability of factors. In country A, there may be an abundance of capital
and labour may be scarce. On the opposite, there may be an abundance of labour in country
B, while capital may be scarce. The terms ‘relative factor abundance’ in H-O model can be
defined in terms of two criteria-
1) The physical criterion of relative factor abundance.
According to this criterion, a country is said to be relatively capital abundant, if and only if, it
is endowed with a higher proportion of capital to labour than the other country. The country
A can be called as relatively capital abundant, if the following condition is satisfied:
where K and L refer to capital and Labour respectively. Bars over K and L signify the fixed
factor quantities in each country. The subscripts A and B refer to countries A and B.
Similarly the realtive scarcity of labour, in physical terms, in country A can be expressed as
Given the above conditions, H-O theory lays down that country A will produce capital-
intensive cpmmodity (say machine) and country B will have a bias in producing labour-
intensive commodity (say,cloth). If both the countries produce machine and cloth in the same
proportion and production occurs along OR in Fig. 1 ,the country A would be
Fig. 1
producing at C and country B at D. The points C and D lie on the respective production
possibilty curves PQ and P1Q1 of these two countries. Since at point C, the slope of country
A’s production possibility curve is more steep more than the slope of the production
possibility possibility curve of country B and D, this will imply that MC of producing cloth in
country A is higher than MC of producing cloth in country B. So if the production takes place
point C and D, machines can be produced more cheaply in country B. Since country A is
capital-abundant and the production of machines is capital-intensive, country A will tend to
extend the production of machines. Country B, at the same time being labour-abundant will
tend to extend the production of cloth, which is realtively labour-intensive.
The Hecksher-Ohlin theorem can, however, be valid on the basis of this physical criterion
and give the above conclusion only if the consumption pattern in both the countries is
identical and the income elasticity of demand for each commodity equals unity. If the
demand conditions are different in two countries, the conclusion that capital-intensive
commodity and vice-versa cannot be sustained. This can be shown through Fig.2.
Fig 2.
Even in Fig the opportunity cost curves PQ and P1Q1 indicate that country A is capital-
abundant and country B is labour-abundant. The pattern of demand is different in the two
countries. The community indifference curves A1, A2 and A3 indicate demand pattern in
country A and the indifference curves B1, B2 and B3 indicate the deamd pattern in country
B. the iso- revenue curve demand pattern in country B. The iso-revenue curve SS1 related to
country A is less steep than the iso-revenue curve TT1 for country B, therefore
Now demand conditions indicate that machines are costly in country A while cloth is costly
in country B. Therfore, country A may decide to export cloth and country B may export
machines. So the pattern of demand may off-set the Hecksher-Ohlin generalisation that
capital-abundant country will export capital-intensive commodity and vice-versa.
Here P denotes prices K and L signify capital and labour respectively. A and B indicate
countries A and B respectively. Similarly, country A can be regarded as labour-abundant and
capital-scarce, if
Now suppose country A is capital-abundant and labour-scarce, the interest rates will be
relatively low and wage rates will be relatively higher compared with interest rates and wage
rates in country B. Therefore, country A will decide to produce and export capital-intensive
commodity (say, cloth). Now this generalization can be proved through Fig 3
Fig 3.
AB is the factor-price line for country A and A1B1 is the factor price line for country B. As
the slope AB is greater than that of A1B1, capital is relatively cheap in country A and labour
is relatively cheap in country B. It signifies that
Now the factor price line AB is tangent to the isoquant M of the capital-intensive commodity
machine at R. It means country A can produce certain number of units of machine, say 100
machines, by employing OK units of capital and OL units of labour is equal to AK amount of
capital. In other words, the cost of producing 100 machines in country A in terms of capital is
OA. The factor price line A2B2 of country B, is parallel to A1B1. It is tangent to the isoquant
M at S. It signifies that country B can produce 100 machines in country A in terms of capital
is OA. The factor price line A2B2 of country B, is parallel to A1B1. It is tangent to the
isoquant M at S. It signifies that country B can produce 100 machines by employing OK1
units of capital and OL1 units of labour. It means A2K1 units of capital are equal to OL1
units of labour and the total cost of producing 100 machines in country B is OA2 in terms of
capital. From this, the conclusion can be derived that the production of machine is more
capital-intensive in country A than in country B.
Similarly in the production of one unit of cloth (say, 1000 meters) in country A, OL2 units of
labour and OK2 units of capital are employed at R1, the point of tangency between country
A’s factor price line AB and the isoquant for cloth C representing 1000 meters of cloth.
Given this factor combination, OK2 units of capital are equal to BL2 units of labour and the
cost of producing 1000 meters of cloth in country A in terms of labour in OB. In country B,
given the factor price line A1B1, the point of tangency between A1B1 and isoquant C is S1.
Country B employs OK3 units of capital and OL3 units of labour for producing 1000 meters
of cloth. Now the quantity of capital OK3 equals B1L3 units of labour. The cost of producing
1000 meters of cloth in labour is labour terms is OB1 in country B. This shows that labour-
abundant country B make more use of labour in producing 1000 meters of cloth than country
A. B will specialise in the production and export of cloth while country A export more
capital-intensive commodity machine.
FACTOR INTENSITIES
The Hecksher-Ohlin theory attributed the comparative differences in cost also to the factor
intensities which have been defined by Ellsworth as “relative use made of each one of the two
(or more) factors when combined in production.” Alternatively, factor intensity means the
relative proportions in which two factors, say labour and capital, are combined at each point
on a given isoquant. This explained through Fig 4.
Fig 4.
C and M in Fig 7.4 represent the isoquants of cloth and machine respectively. They are not
identical otherwise they would have coincide. They intersect each other at R. That indicates
equal factor proportions in producing a given number of units of the two commodities. The
portions to the left and above R is capital-intensive and the portion below and to the right of
R is labour-intensive. Along isoquant M, the quantities of capital and labour used at R1 and
OK1 and OL1 respectively. At R2, these inputs are OK2 and OL3 to have the same output of
machines. Thus above and to the left of R, the factor combinations involve larger input of
capital than labour. The opposite is true on the combinations below and to the right of R. The
same applies even in the case of isoquant C. If OK1 quantity of capital is used, one unit of
machine requires the labour input of OL1 but one unit of cloth requires OL2 of labour along
with OK1 units of capital at point S1. Similarly if OK2 units of capital are employed, one
machine can be turned out when labour input is OL3. At S2. One unit of cloth needs OL3
labour input along with a smaller capital input OK3. It clearly shows that machine is a
capital-intensive and cloth is a labour-intensive commodity, throughout the length of
isoquants M and C except of course at the point of intersection R.
So the relative factor abundance and factor intensity together determine the comparative
differences in costs and accordingly the countries will decide about specialisation and export
of specific commodities. On the basis of factor proportions, factor prices, Hecksher and Ohlin
made the generalisation that capital-intensive commodities and labour-abundant countries
will export labour-intensive commodities.
CRITICISM
No doubt, the Hecksher-Ohlin theory has been found to be more exact, precise, scientific and
analytically superior to the earlier approaches to the theory of international trade, still it has
certain deficiencies for which it has been criticized by many a writer.
1. Partial Equilibrium Analysis
Herberler although recognised Ohlin’s theory as less abstract, yet it has failed to
develop a general equilibrium concept. It remains, by and large, a part of the partial
equilibrium analysis. This theory seeks to explain the pattern of trade only on the
basis of factor proportions and factor intensities, while ignoring several other
influences such as transport costs, economies of scale, external economies etc, which
too exert influence on the cost of production. Ellsworth states that “with several
causes operating simultaneously upon cost, it becomes a matter of adding up the
influence of all costs-reducing and increasing forces to arrive at a net result.
3. Static analysis
The Heckscher-Ohlin assumes fixed quantities of factors of production, given
production functions, income and costs. It means the theory investigates the pattern of
international trade in a static setting. The conclusion drawn from such an analysis are
simply not relevant to a dynamic economic system.
4. Identical factors
This theory maintains that there are no qualitative differences in factors and that these
factors are capable of exact measurements so that endowment ratios can be calculated.
In the real world, however, qualitative factor differences do not exist. Moreover, there
are more than one variety of each factor. This creates serious complications in the
measurement and comparisons of costs and the determinations of trade patterns.
8. Factor mobility
This theory assumes that there is absence of international mobility of factors. This
assumption is not valid. The writers like Williams and Levin have pointed out that the
international mobility of factors is actually even more than international mobility
within the same countries. This is evident from the international capital flows from
advanced countries to such exports sectors in LDC’s as petroleum, minerals,
plantation etc. Similarly the large-scale movement of labour from the Third World
countries to the advanced countries has assisted the latter in enlarging their production
and export. It is, therefore, clear that H-O theory an unrealistic assumption of
international immobility of factors.
Fig 5
Given the identical factor production in two countries A and B, there is the same
production possibility curve PQ for both the countries. A1 and A2 are the community
indifferences curves of A. B1 and B2 are the indifference curve of B. in the absence
of international trade, consumption points of the two countries are respectively R1
and S1. It shows that country A and country B has a greater preference for cloth. As
international trade takes place, TT1 is the international exchange ratio line. Now both
the countries get superior alternatives at R2 and S2 respectively. At R2, country A
consumes R2M of machines and OM of cloth. On the other hand, country B consumes
S2N quantity of cloth and ON quantity of machines at S2. The consumption in excess
of production is met through mutual imports. Thus even when the factor proportions
are identical, the international trade may still occur and that vitiates from the
Heckscher – Ohlin theory.
CONCLUSION
The structure of the modern theory of international trade rests fundamentally upon the theory
developed by Eli Heckscher and Bertlin Ohlin. This theory has almost completely replaced
the classical and neo-classical theories related to international trade. But it does mean that
there is some real conflict between the Heckscher-Ohlin approach and the comparative costs
approach or that the former, in any way, invalidates the latter. In fact, the Heckscher-Ohlin
approach supplements the traditional approach in a powerful manner.
ENDNOTES
BOOKS
K.C. Rana, K.N. Verma, International Economics.
H G Mannur, International Economics (2nd ed.)