topic 4.1

THE HECHSHER-OHLIN MODEL

Topic 4.1

The H-O model differs from the classical model because the explanation for international differences in PPFs is different.

In the classical model there is effectively only one factor of production - labor. The different PPFs reflect different production technologies (using labor) for each country.

In the H-O model technology is the same for all countries but factor endowments are different. This causes the PPFs to be different between countries.

Differing factor endowments are attractive as an explanation for trade because (at least some) factors of production are immobile between countries whereas technology is a public good which flows freely across borders. If there is a superior technology for making a product a country can always license it from abroad.

Assumptions:

• There are two factors of production: labor (L) and capital (K) which are paid wages (W) and rental (R).
  
• Countries have identical production technology.


• In both countries the S industry is more capital intensive than the T industry (notice we use the word 'intensive' when speaking of indutries).


• Countries differ in their endowments of factors of production. Country A is relatively capital abundant (we use 'abundant' with reference to countries).

Since production technology is identical between countries the only reason an industry in A will use a different mix of labor and capital than its counterpart industry in country B is if the wage/rental rate differs between countries.


Let's consider the capital intensity assumption a little futher. What this means is that no matter what the W/R ratio is, industry S always uses a higher K/L than industry T. And this is true for both countries whether they are in autarky or trading with each other.


There are different types of production structure that can insure ('ensure' in British english) that this is true. The simplest is to set K/L at a fixed ratio for every level of production in each industry. This 'fixed coefficients' technology generates right-angle isoquants that expand al0ng a ray from the origin. Whatever the W/R ratio the same K/L will be chosen. Diagrammatically the isocost lines are always tangent at the corner points of the isoquants.















This diagram shows right-angled isoquants (there are actually an infinite number of them) with the K/L ratio fixed for every level of production. Whatever the value for W or R the isocost line will always touch an isoquant at a corner. So production will always use K/L in a fixed ratio.

Capital intensity of A (in this fixed coefficients case) means that the ray for industry S is to the left of the ray for industry T.