Question

The factor proportions, or Heckscher-Ohlin, theorem remains the most important single theory of why relative prices differ before trade, providing insights into the relationship between commodity trade and factor endowments.

1. Provide a common-sense conclusion that can be drawn from this theorem.

2. Discuss two implications of the factor proportions theorem.

Answer 1

a).It is  a general equilibrium mathematical model of international trade developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region .The common sense conclusion includes the results of this work has been the formulation of certain named conclusions arising from the assumptions inherent in the model.It is the exports of a capital-abundant country come from capital-intensive industries, and labour-abundant countries import such goods, exporting labour-intensive goods in return. Competitive pressures within the H–O model produce this prediction fairly straightforwardly. Conveniently, this is an easily testable hypothesis.

b) .Trade theory, like all of economic theory, changed drastically in the first half of the twentieth century. The factor proportions theory developed by the Swedish economist Eli Heckscher, and later expanded by his former graduate student Bertil Ohlin, formed the major theory of international trade and is still widely accepted today. Whereas Smith and Ricardo emphasized a labor theory of value, the factor proportions theory is based on a more modern concept of production that raises capital to the same level of importance as labor.

Two implications are

1. A country that is relatively labor abundant should specialize in the production of relatively labor intensive goods. It should then export these labor intensive goods in exchange for capital intensive goods.
2. A country that is relatively capital abundant should specialized in the production of relatively capital intensive goods. It should then export these capital intensive goods in exchange for labor intensive goods.