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Factor Endowments and the

CHAPTER 5
Heckscher-Ohlin Theory

5.1 Introduction
In this chapter, we extend our trade model in two important directions. First, we
explain the basis of (i.e., what determines) comparative advantage. We have seen in
previous chapters that|the difference in relative commodity prices between two
nations is evidence of their
comparative advantage
beneficial trade We now go one step further and
and forms the basis for
mutually
explain the reason, or cause, for the
difference in relative commodity prices and comparative advantage between the
two
nations.Thesecond way we extend our trade model is to analyze the effect that
internationaltrade has on the earnings of factors of production in the rwo trading
nations.That is, we want to examine the effect of international trade on the
of labor as well as on international differences in earnings
These two important earnings.
questions were left largely unanswered by Smith,
and Mill.According to
classical economists, comparative advantage was basedRicardo,
difference in the productivity of labor (the only factor of production they on the
explicitly
119
120 Chapter S, Ractor indouments stnd the Herkscher (Ohlin 'lte

considered) among nations, but they provided no explanation tor such a dhtfevene
productivity, except for possible ditlerences in climate. The Heckscher-Olin
theory goes uch beyond that by extending the trade model of the previous tivu
chapters to examine the basis for
advantage and the efect that trade has
comparative
on factor
earnings in the two nations.
Section 5.2 deals with the assumptions of the theory. Section 5.3 clarities the
meaning of factor intensity and factor abundance, and explains how the latter is
related to tactor prices and the shape of the production fiontier in each nation. Sec-
tion5.4 presents the Heckscher-Ohlin model proper and illustrates it graphically.
Section 5.5 examines the etfect ofinternational trade on tactor earnings and
ncome distribution in the two nations. Section 5.6 concludes the chapter by
reviewing empirical tests of the Heckscher-Ohlin trade model. The appendix pre
sents the formal derivation of the factor-price equalization theorem and introduces
more advanced tools for empirically testing the Heckscher-Ohlin trade model.

5.2 Assumptions of the Theory

The Heckscher-Ohlin theory is based on a number of
simplifying assumptions
(some made only implicitly by Heckscher and Ohlin). Rather than note these
assumptions along the way às hey are needed in the analysis, it is both logical andd
convenient to present them together and
will not only allow us to view the
explain their meaning at this point. This
will also make the
theory to be presented in a better perspective but
presentation smoother and more direct. To make,the theory more
realistic, we will relax these assumptions in the next chapter and examine the effeect
that such relaxation has on the conclusions reached in
this chapter.

5ZK The Assumptions

The Heckscher-Ohlin theory is based the
on
following assumptions:
1. There are two nations
(Nation 1 and Nation 2), two commodities
ity X and commodityY), and two factors of production (labor and(commod-
2. Both nations use the same technology in
capital).
production.
3. Commodity X is labor intensive, and commodityY is capital intensive in both
nations.
4. Both commodities are produced under constant returns to scale in both
nations.
5. There is incomplete specialization in production in both nations.
6. Tastes are equal in both nations.
7. There is perfect competition in both commodities and factor markets in both
nations
8. There is perfect factor mobility within each nation but
tor mobility.
no international fac-
inTheon

ssumptions of the Theory (of

rhiencein 121
wo 9. There are no transportation costs, tariffs, or other obstructions to the free flow
of international trade.
10. All resources are fully employed in both nations.
11. International trade between the two nations is balanced.

5.2B Meaning of the Assumptions

The meaning of assumption 1 (two nations, two commodities, and two factors) is
clear, and it is made in order to be able to illustrate the theory with a two-dimen-
sional figure. This assumption is made with the knowledge (discussed in the next
chapter) that its relaxation (so as to deal with the more realistic case of more than
two nations, more than two commodities, and more than two factors) will leave the
concusions of the theory basically unchanged.
Assumption 2 (that both nations use the same technology) means that both
nations have access to and use the same general production techniques. Thus, if fac-
tor prices were the same in both nations, producers in both nations would use
exactly the same amount of labor and capital in the production of each commodity.
Since factor prices usually differ, producers in each nation will use more of the rel-
atively cheaper factor in the nation to minimize their costs of production.
Assumption 3 (that commodity X is labor intensive and commodity Y is capi-
tal intensive) means that commodity X requires relatively more labor to produce
than commodity Y in both nations. In a more technical and precise way, this means
that the labor-capital ratio (L/K) is higher for commodity X than for commod-
ity Y in both nations at the same relative factor prices. This is equivalent to saying
that the capital-labor ratio (K/L) is lowerfor X than for Y. But it does not mean
that the K/L ratio for X is the same in Nation 1 and Nation 2, only that K/L is
lower for X than for Y in both nations. This point is so important that we will use
Section 5.3A to clarify it.
Assumption 4 (constant returns to scale in the production of both commodi-
ties in both nations) means that increasing the amount of labor and capital used in
the production of any commodity will increase output of that commodity in the
same proportion. For example, if Nation 1 increases by 10 percent both the amount
of labor and the amount of capital that it uses in the production of commodity X,
its output of commodity X will also increase by 10 percent.Ifit doubles the amount
of both labor and capital used, its output of X will also double. The same is true for
commodity Y and in Nation 2.
Assumption 5 (incomplete specialization in production in both nations) means
that even with free trade both nations continue to produce both commodities. This
impliesthat neither of the two nations is "very small"
Assumption 6 (equal tastes in both nations) means that demand preferences, as
reflected in the shape and location of indifference curves, are identical in both
nations. Thus, when relative commodity prices are equal in the two nations (as, for
example, with free trade), both nations will consume X and Y in the same propor
tion.This will be illustrated in Section 5.3C.
Assumption 7 (perfect competition in both commodities and factor markets)
means that producers, consumers, and traders of commodity X and commodity Y in
 122
Chapter 5. Factor Endowments and the Heckscher-Ohlin' s
both naions are
is true for each each
too small to affect the
user and
price of these commodities. The sa
means that, in the supplier of labor time and capital. Perfect competition al
long run, commodity
ing no (economic) profit after all costsprices equal their costs of production, leav
account.
ers of
Finally, perfect competition means(including implicit costs) are taken into
that all producers,
tactors of consumers, and own-
tor production have perfect knowledge of
earnings in all parts of the nation and in all commodity prices and fac-
industries.
Assumption 8 (perfect internal
mobility) means that labor and factor mobility but no international factor
quickly, from areas and industries ofcapital are free to
move, and indeed do move
earnings until lower earnings areas and industries of
to
earnings for the
areas, uses, and industries of the same type of labor and capital are the same higher
tional factor nation. On the other in all
mobiity
national differences in (i.e., no mobility of factors
hand, there is zero interna-
factor earnings would among nations), so that
international trade. persist indefinitely in the absence inter
of
Assumption 9 (no transportation costs,
flow of
international trade) means that tarifs, or other obstructions to the free
relative (and specialization in production proceeds untia
we allowed absolute) commodity prices are the
for same in both
until relative transportation costs and
tarifs, nations with trade. If
(and absolute)
transportation and the tariffcommodity specialization
prices differed would proceed
only
on each
until by no more
than the costs of
Assumption 10 of the
commodity traded.
there are no (all resources are fülly
unemployed employed
resources or factors of
in both nations) means that
Assumption 11
that the total value(international trade between the two production in either nation.
of each nation's nations is balanced)
imports. exports equals the total value means
of the nation's

5.3 Factor
Intensity,
the Production Factor
Frontier Abundance, and the Shape of
Since the
Heckscher-Ohlin theory to be
terms of factor
intensity and factor abundance,presented in Section 5.4
is
terms be
very clear and precise.
it is crucial that the expressed in
and illustrated in Hence, the
Section 5.3A. In Section meaning of factor meaning of these
abundance and its 5.3B, we examine the intensity explained
is
the
relationship relationship to factor
prices. in Section meaning of factor
of each nation. between factor abundance and Finally,
the 5.3C, we examine
3 Ro Jo
shape of the production frontier
undeultand H-0 Jheo u
dutond
5.3A Factor Intensity H
ollo n9
mnotant
dmnoltonk to
3 Con unt
to

In a world of two commodities

Conu -
O,that commodityY
duction of Y is is capital
X andY) and two factors
intensive if the (labor and capital), we say
greater than K/L used capital-Habor ratio
production of X.(K/L)
in the used in the
pro-
 hlin Th
e san Factor Intensity, Factor Abundance, and the Shape of the Production Frontier 123
also For example, if two units of capital (2K) and two units of labor (2L) are
to produce one unit of commodity Y, the capitalHabor ratio is one. That is,required
K/L =
2/2= 1 in the production of Y. If at the same time 1K and 4L are
required
duce one unit of X, K/L = /4 for commodity X. Since K/L = 1 for
to pro-
Y and K/L =
V4 for X, we say that Y is K intensive and X is L intensive.
Note that|it is not the
absolute amount of capital and labor used in the production
of commodities X andY that is
important in
measuring the
capital and labor
inten-
sity of the two commodities, but
the amount of capital per unit of
For example, suppose that 3K and 12L labor (i.e., K/L).J
duce 1X, while to produce 1Y
(instead of 1K and 4L) are required to pro-
requires 2K and 2L (as indicated earlier). Even
though to produce 1X requires 3K, while to produce 1Y requires only 2K, com-
modity Y would still be the K-intensive commodity because K/L is higher for Y
than for X.That is, K/L 2/2 1 forY, but K/L /2 1/4
= = =

If we plotted capital (K) along the vertical axis of a

=
for X.
horizontal axis, and production took place along a
graph and labor (L) along the
the slope of the line would measure the
straight-line ray from the origin,
of the
capital-labor ratio (K/L) in the production
commodity.This is shown in Figure 5.1.
Figure 5.1 shows that Nation 1 can produce 1Y with 2K and 2L. With 4K and
4L, Nation 1 can produce 2Y because of constant returns to scale (assumption 4).
Thus, K/L= 2/2 =44= 1 forYThis is given by the slope of 1 for ray
the from the
origin for commodity Y in Nation 1 (see the figure). On the other hand, 1K and 4L (a
are required to produce 1X, and 2K and 8L to produce 2X,in Nation 1.Thus, K/L
=
/4 for X in Nation 1.This is given by the
for commodity X in Nation 1. Since
slopeof l/4 for the ray from the origin
K/L, or the slope of the ray from the origin,,
is higher for commodity Y than for commodity X, we say that commodity Y is K
intensive and commodity X is L intensive in Nation 1.
In Nation 2, K/L (or the slope of the ray) is 4
for Yand 1 for X (see Figure 5.1).
Therefore,Y is the K-intensive commodity, and X is the L-intensive commodity in
Nation 2 also. This is illustrated by the fact that the ray from the origin for com-
modityY is steeper (i.e., has a greater slope) than the ray for commodity X in both
nations.
Even though commodity Yis Kintensive in relation to commodity Xin both
nations,Nation 2 uses ahigher K7L in producing bothYand Xthan Nation 1.ForY,
K/L = 4 in Nation 2 but K/L =1 in Nation 1. For X, K/L = 1 in Nation 2 but
K/L = 1/4 in Nation 1.The obvious question is: Why does Nation 2 use more K-

intensive production techniques in both commodities than Nation 1? The answer is

that capital must be relatively cheaper in Nation 2 than in Nation 1,so that produc-
ers in Nation 2 use relatively more capital in the production of both commodities
to minimize their costs of production. But why is capital relatively cheaper in
Nation 2? To answer this question, we must define factor abundance and examine
its relationship factor prices.
to
Before doing this, however, we must settle one other related point of crucial
importance.This refers to whathappensif,for whateverreason,therelativeprice of
capitalfals. Producers would substitatecapitalfor labor in the production of both_
commodities
t o minimize their costs of production As a result, both commoditiess
would become more Kintensive.However, only it K/L in the production of com-
modity Y exceeds K7L in theproduction of commodity X at all possible relativefactor
 actorintensi.
the Heckscher-O
124 Chapter 5. Factor Endowments and phlin
K Nation 2

10 in Y-4

Nation 1 2Y

In Y1 In X1
4 1Y
2X

2X x
2
0 1 2
FIGURE 5.1. Factor Intensities for
Commodities X and Y in
Nation 1, the capita-labor ratio (K/L) equals 1 for commodity and Nations 1 and 2. In

modity X.These are given by the slope of the ray from the Y for K/IL 1/4 for com-
=

Yis the K-intensive commodity origin

Nation 1.Thus, each commodity in
4 for Y and K/Lcommodity in Nation 1. In Nation
=
1 for X. Thus, 2, K/L
modity X is the commodityY is the
L-intensive commodity in both nations.K-intensive commodity, and com-
Nation 1 in the Nation 2 uses
higher K/L than
production
is lower in Nation
of both commodities
because the relative
a
2. If r/w
of both commodities to declined, producers would substitute K forprice of capital (r/w
minimize their costs of Lin the
both commodities. production
production. As a result, K/L would rise for

prices can we say unequivocally that commodity Yis the

is basically an empirical
will assume that this is question and will be exploredK-intensive commodityThis
in Section 5.6.
modity at all possible relative (i.e.,
true that For now, wwe
factor commodity Y remains the
K-intensive
To summarize, we prices).. com-
modity if K/L is highersayforthat commodity Y is unequivocally the
ative factor
prices. Nationcommodity
2 uses a
Ythan for commodity X K-intensive
at all
com-
commodities because the higher K/L in the possible rel-
Nation 1. If the relative relative price of capital is lower production of both
the price of capital declines, in Nation 2
production
K/L will rise for
of both
commodities producers will substitute than in
both
to
minimize their costs of Kfor Lin
modity. commodities, but Y continues to
be the production. Thus,
K-intensive com-
5.3BFactor Abundance
There are two ways to
units (i.e., in terms of define factor
the overall abundance. One way is in
nation). Another way to define amount of capital and terms of
prices (ie, in terms factor abundance is in labor available physical
to each
nation). of the rental price of terms of
capital and the price of relative factor
labor time in each
hlin 7) TE ITC
P-IPLA
Factor Intensity, Factor Abundance, and the
Shape of the Production Frontier 125
According to the definition in terms of physical units, Nation 2 is capital abun-
dant if the ratio of the total amount of
capital to the total amount of labor (TK/TL)
available in Nation 2 is greater than that in Nation 1
(i.e., if TK/TL for Nation 2
exceeds TK/TL for Nation 1). Note that it is not the absolute amount of
and labor available in each nation that is capital
of capital to the total amount of labor.
important but the ratio of the total amount
Thus, Nation 2 can have less capital than
Nation 1 and still be the
TK/TL in Nation 1.
capital-abundant nation if (TK/TL in Nation 2 exceeds
According to the definition in terms of factor prices, Nation 2 is capital abundant
if the ratio of the rental
price of capital to the price of labor time (Pk/PL) is lower in
Nation 2 than in Nation 1 (i.e., if
Nation 1). Since the rental price of
Pg/P in Nation 2 is smaller than Px/PL in
while the price of labor time is the
capital is usually taken to be the interest rate ()
wage rate (w), Px/PL 1/w. Once
the absolute level ofr that determines whether or not a nation is again,
it is not
the K-abundant
nation, but r/w. For example, r may be higher in Nation 2 than in Nation 1, but
Nation 2 will still be the K-abundant nation
if r/w is lower there than in Nation 1.
The relationship betvween the two definitions of factor abundance is clear. the
définition of factor abundance in terms of physical
units considers
of factors. The definition in terms of relative factor prices considersonly
the supply
and both demand
supply (since we know from principles of economics that the price of a com-
modity or factor is determined by both demand and supply considerations under
perfect competition). Also from principles of economics, we know that the demand
fora factor of
production is a derived demand-derived from the demand for the
final commodity that requires the factor in
iis production.
Since we have assumed that tastes, or demand
preferences, are the same in both
nations, the two definitions of factor abundance give the same conclusions in our
case. That is, with TK/TL
larger in Nation 2 than in Nation 1 in the face of
demand conditions (and technology), Pk/PL will be smaller in Nation 2. equal
Nation 2 is the K-abundant nation in terms of both definitions.
Thus,
This is not always the case. For example, it is conceivable that the demand for
commodity Y (the K-intensive commodity), and therefore the demand for capital,
could be so much higher in Nation 2 than in Nation 1 that the relative
ital would be higher in Nation 2 than in Nation 1
price of cap-
(despite the relatively abun-
supply of capital in Nation 2). In that case, Nation 2 would be considered Kgreater
dant according to the definition in physical terms and L abundant according to the
definition in terms of relative factor prices.
Insuch situations, it is the definition in lerma ef relative factorprices that should be used.
That is, a nation is Kabundant if the relative price of capital is lower in it than in the
other nation. In our case, there is no such contradiction between the two defini-
tions. Nation 2 is Kabundant and Nation 1 is L abundant in terms of both defini-
tions. We will assume this to be the case throughout the rest of the chapter, unless
otherwise explicitly indicated.

5.3c Factor Abundance and the Shape of the Production Frontier

Since Nation 2 is the K-abundant nation and commodity Y is the K-intensive com-
modity, Nation 2 can produce relatively more of commodity Y than Nation 1. On
126 Chapter 5. Factor Endowments and the Heckscher-Ohlin
the other hand, since Nation 1 is the L-abundant nation and
intensive commodity, Nation 1 can
commodity X is the
produce relatively more of commodity X tha
Nation 2.This gives a production frontier for Nation 1 that is relatively flatter and
wider than the production frontier of Nation 2 (if we measure A along the hori-
zontal axis).
In Figure 5.2, we have plotted the production frontiers of Nation 1 and Nation 2
on the same set of axes. (These are the same production frontiers introduced with
Figure 3.1 and used throughout Chapters 3 and 4.) Since Nation 1 is the L-abun-
dant nation and
commodity X is the L-intensive commodity, Nation 1's production
frontier is skewed toward the horizontal
axis, which measures commodity X. On
the other hand, since Nation 2 is the
K-abundant nation and commodity Y is the
K-intensive commodity, Nation 2's
cal axis measuring
production frontier is skewed toward the verti-
set
commodity Y. The production frontiers are plotted on the same
of axes so that the difference in their
this will facilitate the illustration of the
shape is more clearly evident and because
Case Study 5.1
Heckscher-Ohlin model in Section 5.4C.
presents the relative resource endowments of various countries and
regions, while Case Study 5.2 gives the capital stock per worker for a number of
leading developed and developing countries.
Having clarified the meaning of factor intensity and factor abundance, we are
now ready to present the Heckscher-Ohlin theory.

140 Nation 2

120

100

80
70 Nation 1
60

40

20

X
0 20 40 60 80 100 120 1400

FIGURE 5.2. The Shape of the Production Frontiers of Nation 1 and Nation 2.The
production fronier of Nation 1 is fatter and wider than the production frontier of Nation
2. indicating that Nation I can produce relatively more of commodity X than Nation 2.
The reason for this is that Nation 1 is the L-abundant nation and commodity X is the L-
intensive commodity.
 Case Study 5-1 Relative Resource Endowments of Various Countries
and Regions
Table 5.1 gives the share of the worlds resource endowments of
capital, skilled
labor, and unskilled labor of the various nations and regions in 1993. The table
shows that the United States has 20.8 percent of the world's capital, 19.4 percent of
the skilled labor, and 2.6 percent of the unskilled labor. These amount to 5.6
percent
of the world's resources of these factors. Since the United States has a greater relative
share of the world resources of capital and skilled labor (20.8% and 19.4%, respec-
tively,compared with 5.6% of all the world's resources of capital, skilled labor, and
unskilled labor combined), we can expect the United States to have a comparative
advantage in capital- and skill-intensive commodities and a comparative disadvan-
tage in unskilled-intensive commodities. The situation is similar for other industri
alized countries. For China, India, the rest of Asia, Eastern Europe (including
Russia), OPEC, and the rest of the word, the opposite is the case. Mexico and the
rest of Latin America seem to have a comparative advantage in capital-intensive
commodities, a comparative disadvantage in skill-intensive commodities, and nei-
ther a comparative advantage nor a comparative disadvantage in unskilled-intensive
commodities. Hong Kong, South Korea, Taiwan, and Singapore seem to have a
comparative advantage in capital-and skill-intensive commodities.

TABLE 5.1. Factor Endowments ofVarious Countries and Regions, as a Percentage of

the World Total in 1993
Skilled Unskilled All
Country/Region Capital Labor Labor Resources

United States 20.8% 19.4% 2.6% 5.6%

European Union 20.7 13.3 5.3 6.9

Japan 10.5 8.2 1.6 2.9

Canada 2.0 1.7 0.4 0.6
Rest of OECD" 5.0 2.6 2.0 2.2

Mexico 2.3 1.2 1.4 1.4

Rest of Latin America 6.4 3.7 5.3 .1

China 8.3 21.7 30.4 28.4

India 3.0 7.1 15.3 13.7
Hong Kong, South Korea
Taiwan, Singapore 2.8 3.7 0.9 1.4
Rest ofAsia 3.4 5.3 9.5 8.7

Eastern Europe
(Including Russia) 6.2 3.8 8.4 7.6
OPEC 6.2 4.4 7.1 6.7
Rest of the World 2.5 4.0 10.0 8.9

Total 100.0 100.0 100.0 100.0

OECD Organization for Bconomic Cooperaion and Development, which includes all the other
industrial countries.
OPEC = Organization of Petroleum Exporting Countries.
Source: Elaboration on W Cline, Trade and Income Distribution (Washington, D.C.: Institute for Inter-

national Economics, 1997), pp. 183-185.

 128
Chapter 5. Factor Endowments and the
Heckscher-Ohlin
Case Study 5-2
Capital-Labor Ratios of Selected Countries
Table 5.2 gives the capital stock per worker of a number of
oping countries in 1993. Capital stocks are developed and devel
measured in 1990
prices to reflect the actual purchasing power of the dollar in international dollar
each country, thus
allowing meaningful
States has a lowet
international comparisons. The table shows that the United
capital
countries (the left-hand
stock per worker than
many other industrial or developed
part of the table) but a much
worker than
developing countries (the right-hand part ofhigher
5.2, we can thus the
capital stock per
infer that the table). From Table
intensive commodities with United States has a comparative advantage in
many other developed or respect developing countries but not with respect to
to capital
data presented industrial countries. This is broadly consistent
in Table 5.1. with the
TABLE 5.2.
international dollarCapital
prices)Stock per Worker of Selected Countries in 1993 (in 1990
Developed Country 1993
Japan Developing Countryy 1993
77,429
Germany 61,673
Korea 26,635
Canada Chile
France 61,274 Mexico 17,699
United States 59,602 14,030
50,233 Turkey 10,780
Italy Thailandd 8,106
Spain 48,943
United Kingdom 38,897 Philippines
India
6,095
30,226 3,094
Kenya 1,412
Peliminary results;
Soure: R Summers excludes
residential
construction
and A. Heston, Penn capital.
Wold Table
(Spring 2000, Mark 5.7).

5.4 Factor Endowments and the

6

(In 1919 Eli Heckscher, a

Heckscher-Ohlin Theory
of Foreign Trade Swedish economist, published an article
of what was to
on the Distribution of
Income," in entitled "The Efect
become the "modern theory of which he presented the outline
largely unnoticed internationaltrade.The article went
and former studentfor over ten years until Bertil Ohlin,
of Heckscher, picked it up, built another Swedish economist
published his famous book Interregional and it, clarified it, and in
on
1933
We will discuss only Ohlin's work, sinceInternational
it
Trade.
said in his article and incorporates all
since the essence ofthat Heckscher had
much
introduced by Heckscher, due However,
more.
the model was first
Heckscher-Ohlin theory. Ohlin,credit
on his
is given to him
by calling the theory the
Nobel prize in economics for his work part, shared (with James
Meade) the 1977
HockshR
1 9 1 9
(The Heckscher-Ohlin (H-0) in international trade.
form of two theorems: the theory can be presented in a
so-called H-O theorem nutshell in the
Betf
ohliin
(which deals with and predicts
 Factor Endowments and the Heckscher-Ohlin Theory 129
the pattern of
trade) and
effect of international tradethe facto7-price equalization theorem (whichdeals with the
on factor prices).The
wil be discussed in Section 5.5. In this section, factor-price equalization theorem
theorem. We begin with a statement of the we
present and discuss the H-O
theorem and briefly explain its
Then we examine the
general equilibrium nature of the H-O theory, and
meaning.
give geometrical interpretation of the model.
a finally we

5.4A The
Heckscher-Ohlin Theorem
Starting with the
assumptions
presented in Section
5.2, state thewe
(Heckscher-Ohlin
duction
theorem follows: Anation will
as
the
export commodity whose pro-
can

requires
the intensive use of the nation's
relatively abundant and cheap factor and
import the commodity whose
production requires intensive use of the nation's relatively
the
scarce and
expensive factor. In short, the relatively labor-rich nation
tively labor-intensive cómmodity and imports the relatively exports the rela-
modity. capital-intensive com-
In terms of our
previous discussion, this means that Nation 1 exports comnod-
ity X because commodity X is the L-intensive
commodity and Lis the relatively
abundant and cheap factor in Nation 1. On the other
hand, Nation 2
modity Y because commodity Y is the K-intensive commodity and Kexports com-

tively abundant and cheap factor in Nation 2 (i.e., r/w is lower in Nationis 2the rela-
than in
Nation 1).
Cofall the possible reasons for differences in relative commodity
parative advantage among nations, the -O theorem isolates the differenceprices and com
tive factor in rela-
abundance, or facor endowments, among nations as the basic cause o r
determinant of comparative advantage and
international trade,For this reason, the
H-O model is often referred to as the factor-proportions
ment theory, That is, each nation qr factor-endow-
specializes in the production of and exports the
commodity ñtensive in its relatively abundant and cheap factor and imports
commodity intensive in its relatively scarce and expensive factor. the
Thus, the H-O theorem explains comparative advantage rather than
(as was the case for classical economists). That is, the H-O theorem assuming
it
the difference in relative factor abundance and postulates that
prices is the cause of the
ference in relative commodity prices between two nations.This pretrade dif-
difference in relative
factor and relative commodity
prices is then translated into a difference in absolute
factor and commodity prices between the two nations
It is this difference in
(as outlined in Section 2.4D).
absolute commodity prices in the two nations that is the
immediate cause of trade.

5.4B General Bquilibrium Framework of the Heckscher-Ohlin Theory

The general equilibrium nature of the H-O theory can be visualized and summa-
rized with the use of Figure 5.3. Starting at the lower
right-hand corner of the dia-
gram, we see that tastes and the distribution in the ownership of factors of
production (i.e., the distribution of income) together determine the demand for
commodities. The demand for commodities determines the derived demand for the