Chapter IV: The Heckscher-Ohlin model

I. Introduction
- In 1919, Eli Heckscher published an article: "The effect of foreign trade on the distribution of
income".
- In 1933, Bertil Ohlin was a student of Heckscher, developed the idea and model of Hecksher,
producing a very famous book: "Interregional and International Trade".
- In 1977, Ohlin received a Nobel Prize in economics.
II. Heckscher- Ohlin Theorem (H-O model)
“The Heckscher-Ohlin Theorem says that countries will export products that use their abundant
and cheap factor of production and import products that use the countries' scarce factor”
III. Opinion of Heckscher-Ohlin
1. The factors regulation trade
a. Factor intensity
Consider a simple model consisting of only two basic resources: labor (L) and capital (K), used to
produce two goods X and Y.
Ø X is the labor intensive good if:

L X LY
>
KX KY

Ø X is the capital intensive good if:

KX KY
>
L X LY

With:
 L X and LY are the labor needed to produce a unit of goods X and goods Y.
 K X and K Y are the capital needed to produce a unit of goods X and goods Y.
b. Factor abundance
Consider a simple model with two countries A and B including only two production factors, K and
L.
Ø A is the capital abundant country if:

KA KB
>
L A LB

Ø A is the labor abundant country if:

L A LB
>
KA KB
With:
 K A and L A are the total capital and labor of country A
 K B and LB are the total capital and labor of country B
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If base and labor hire price and capital embroidery price (in cash or machinery) country A is also
considered to be abundant in labor factors if:
WA WB
<
r A rB
With :
 W A and r A are labor rents and capital rents in country A
 W B and r B are labor rents and capital rents in country B
2. Assumptions of the Heckscher Ohlin Model
 Consider the 2 ×2 ×2 model ie the world consists of 2 countries, 2 factors of production (labor
and capital) and 2 goods.
 Countries have similar production technology. Countries will share the same technologies.
Though it is not realistic, this assumption is taken so that it eliminates the trade differences
because of technological differences.
 Prices are the same everywhere.
 The tastes in the two countries are identical. Similar to technology, this is assumed to eliminate
the difference in tastes.
 The two countries have different relative factor endowments namely capital, land and labor.
Based on the relative factor endowments, countries are classified as capital abundant, labor
abundant or land abundant.
 Factor Intensities may vary. Similar to above, based on relative factor intensities, goods are
classified as capital intensive, labor-intensive
 Perfect Competition:

 Firms in the market get to choose the output level at which price equals marginal costs.
 In response to profit, there is free entry and free exit of firms in the market.
 Necessary information is available and is perfect.

 There are no transport costs and no hindrances in trade.

 There are no trade restrictions between the two countries

IV. The Heckscher-Ohlin model

1. H-O model
For example, the model of two countries Vietnam and South Korea with two goods is coffee and
steel, and the two production factors are labor. In addition,Vietnam is the labor abundant
country, while South Korea is the capital abundant country.

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Autarky : when economics don't exist the exchange of goods between
countries"Autarky" thường được hiểu là "tự cung tự cấp"

Keeping the above assumptions, because coffee is a labor-intensive commodity, the limit of Vietnam's
production capacity is gradually reduced to the vertical axis - the axis denoting the coffee item.
Similarly, because Korea is assumed to be a capital-rich country and steel is a capital-intensive
commodity, the limit of Korea's production capacity gradually decreases to the horizontal axis - the
axis represents the steel item.
Split the "H-O Model" into two images: " autarky equilibrium " or before trade and "trade equilibrium"
or after trade.

Because the two countries are assumed to have similar preferences, the two countries share the same
set of indifference curves I.
Before commercial exchange, Vietnam produced and consumed at N 0 while South Korea produced and
consumed at V 0 (Autarky). N 0 and V 0 are the two point between the lines that limit the production
capacity of the two countries and indifference curves I 0.

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P A and PB are the correlated prices between steel and coffee. Look at the picture P A has a gently slope
than PB so steel in Korea is relatively cheaper than Vietnam. In contrast, coffee is cheaper in Vietnam
than in Korea, so Vietnam has a comparative advantage in coffee.

At that time, Vietnam and Korea carried out the specialization process. At that time, the production
points of Vietnam tended to move upwards along the production possibility curve of Vietnam, while
the production points of Korea moved downwards along the production possibility curve Korea. When
there is international trade, coffee prices will increase in Vietnam and decrease in Korea. The
production and exchange specialization process continues until the price correlation between coffee and
steel in the two countries becomes balanced, and then Vietnam reaches a new production point N 1,
while Korea reaches a new production point V 1. At that time, Vietnam will consume at point C N and
while Korea will consume at point C V . You can see that C V is on a lower indifferent curve ( I 1) than
Vietnam’s indifferent curve. Therefore, Vietnam’s benefits from trade higher than Korea. However, the
most important thing here is that since international trade exchange, both Vietnam and Korea have been
beneficial because they have achieved a higher indifference curve than the case of autarky.
At the balanced international price Korea exports V 1 L steel in exchange for C V L coffee from Vietnam.
Vietnam also exports N 1 K coffee in exchange for C N K steel from Korea. We can see that the export of
this country is equal to the import of the other and vice versa.
 N1 K = CV L
 CN K = V 1 L

Therefore, the two trade triangles of Korea and Vietnam are similar.

2. General equilibrium structure of H-O theory.

Price of goods

Demand of
Price factor of production production
4
factors
 Demand for the
final goods

Supply of
production Hobby Distribution
factors allocation of
production
factors

The red arrow indicates the influence relationship between the two countries' identical factors, the blue
arrow indicates the influence relationship between the different factors between the two countries.
Through this diagram H-O theory explains why the difference in the abundance of production factors
leads to the difference in the prices of goods produced in two different countries which is also the
reason for trade between the two countries. Starting from the lower right corner of the diagram can be
seen: because the interests and distribution of ownership factors (income distribution) in the two
countries are the same, the demand for goods of the two countries is the same . While the ability to
supply production factors of the two countries is not the same, so will lead to differences in prices of
production factors in the two countries. Finally, with the same technology but different production
factors prices will make the relative prices of goods different in the two countries. Thus, the difference
in the abundance of production factors (supply of production factors) is the decisive factor in the price
difference of goods. And it is the difference in the final price of goods, in free trade, perfect
competition, and transportation costs equal zero that motivate countries to conduct international trade.

V. Advantage and disadvantage of Heckscher-Ohlin Theory

1. Advantage
 As one of the most influential theories to international economics, holding a central
position in the theory of international trade
 Identify the factors that directly affect the price => is one of the important factors in the
price determination process of the product.
2. Disadvantage
 Not to mention the differences in labor quality between countries.
 In pact, production technology between the two countries is different.
 Not to mention the trade barriers such as taxes, tranpostation costs, quotas,..