Factor

Endowment
Theory
(Heckscher-Ohlin Model)
1

Eli Filip Heckscher was a Swedish political

economist and economic historian. He studied
at university in Uppsala and Gothenburg,
completing his PhD in Uppsala in 1907. He
was professor of Political Economy and
Statistics at the Stockholm School of
Economics from 1909 until 1929, when he
exchanged that chair for a research
Eli Filip Heckscher professorship in economic history, finally
(1879-1952)
retiring as emeritus professor in 1945.
Heckscher worked so hard in his life, till 1949, he had published 1148
books and articles, among which may be mentioned his study of
Mercantilism, translated into several languages.
In 1919, Heckscher published a research paper in Swedish The Effect
of Foreign Trade on the Distribution of Income, in which he
introduced basic ideas about how to put trade on the basis of a
countrys factor endowment.
2

Bertil Ohlin
(1899~1979)
Jointly won
Nobel prize for
economics with
James Edward
Meade in 1977.

Bertile Ohlin was born into an upper-middle class

family in a village in the South of Sweden. He got his
B.A. from Lund University 1917, M.A. from Harvard
in 1923, and Ph.D from Stockholm University in
1924. In 1925 Ohlin became a professor at the
University of Copenhagen. In 1930 he succeeded Eli
Heckscher, his teacher, as a professor of economics,
at the Stockholm School of Economics.
Ohlins results were firstly published in his doctoral
dissertation in Swedish, Theory of Trade in 1924,
and afterward, far more fully in his well known book
in the Harvard Economic Series, Interregional and
International Trade in 1933.

In this Ohlin built an economic theory of international trade from

earlier work by Heckscher and his own doctoral thesis. It is now
known as the Heckscher-Ohlin Model, one of the standard model
3
economists use to debate trade theory.

For thirty years from 1919 till 1949 few scholars in the academic
circle of international trade knew Eli Hechscher but most of them
would be very much familiar with a famous name Bertil Ohlin. People
once mentioned the theory of factor endowment as Ohlin model.
Heckscher and his paper did not popularize at least for two reasons.
At first the paper published in 1919 when the World War One just
ended. The interests of the major powers in the world at that time
were not on the issues of trade theory.
Secondly, Heckscher had his academic activities mostly in Sweden
and the paper was published in Swedish. But we know that Swedish is
not as wide spread as English.
Therefore, when Ohlin was well known and the theory was once
termed as Ohlin model people seldom knew that it was Heckscher
who was the originator of factor endowment theory.
Heckschers article was first widely introduced to the academic circle
in 1949 when American Economic Association included his famous
paper in The Readings in the Theory of International Trade
published in English with the contributive helps of Professor Svend
Laursen and his wife who had undertaken the trouble of translating
Swedish text of the paper into a proficient
English.
4

Heckschers Illustration on

Factor
Endowment
Theory
5

Two Theoretical Assumptions of Heckscher

Heckscher established his theory on two assumptions:

First, changes induced by foreign trade in the nature of the
factors of production (dynamic changes) are completely
disregarded. Thus the quantity of factors of production within
a country is given;
Second, no attention is paid to the advantages one particular
country may achieve by means of protection. That is to say he
only discussed problem of international trade in the
framework of free trade.
If one initially employs all of the
above assumptions it follows
from the nature of barter that
trade will create the maximum
satisfaction of wants or the
maximum national income .
6

Source of
Trade Benefit

Such a gain in total satisfaction arises

whenever the law of comparative costs
operates ( ), i.e.,
whenever a want is more easily satisfied in an
indirect way, through the production of
another commodity which can be exchanged
for the commodity desired, than by producing
the latter directly.
By trading with the other country it would be
cheaper for the home country to indirectly
meet the home demand for particular goods
by importing such goods from abroad, which
could be paid with its own exportable goods,
rather than directly meet the demand by
producing import substitution goods at
7
home.

Its so obvious that

trade on the basis
of comparative
cost advantages is
the real source of
trade benefit. In
order maximize a
countrys national
income the
country must be
active in trade
rather to meet all
of consumption
wants of its
residents directly.

From Where Derives Comparative Advantages

No different factor endowment no differences in relative

price of production factors and no different comparative
costs of products consequently no trade between different
countries. It has been strongly suggested that different
factor endowment between different countries must be the
basic pre-requisite for trade between them. Besides that
there must be different proportions of production factors in
producing different goods.
Heckscher mentioned the former as a necessary condition
for a difference in comparative costs and consequently for
international trade and he mentioned the latter as a further
indispensable condition.
From these two important conditions comparative
advantages of particular country could be derived.
8

How did Heckscher illustrate his ideas?

A difference in the relative scarcity of the factors of production

between one country and another is thus a necessary condition
for a difference in comparative costs and consequently for
international trade.
A further indispensable condition is that the proportions in
which the factors of production are combined shall not be the
same for one commodity as for another. In the absence of this
second condition, the price of one commodity, compared with
the price of another would remain the same in all countries
regardless of differences in relative factor prices.

The prerequisites for initiating international trade may thus be

summarized as different relative scarcity, i.e., different relative
prices of the factors of production in the exchanging countries, as
well as different proportions between the factors of production in
different commodities.
9

Ohlins Illustration on

Factor
Endowment
Theory
10

How does a country differentiate

from another?

There should be some kind of natural distinction between

regions.
The principal criterion used to differentiate one region from
another is its endowment with factors of production.
Hence, regions have different factor endowments, while the
factors within a region are essentially similar.

11

Varying Ability and Advantages of

Specialization

What are the causes of division of labor in general?

Why do individuals trade with each other, instead of
each one producing his own requirements?
Why does division of labor increase the total
efficiency of production?
The reasons may be grouped under two headings:
varying ability and advantages of
specialization.

12

First of all, some individuals have greater ability for certain

tasks than others. Varying natural aptitudes make one more fit
to be an engineer, another better suited for the work of
physician or a lawyer. Some people take greater interest in
gardening than in other occupations, and hence probably
make better gardeners than others. Examples could be
multiplied.
Second, even if all individuals had exactly the same natural
abilities, it would be still be advantageous to have
specialization in one or a small number of occupations. In
this way much greater skill can be acquired than if everyone
produced everything for himself. Furthermore, the workman
who constantly attends to one task wastes no time changing
over from one occupation to another.
In short, there results an increase in skill and a saving of
time when each individual is occupied in the production of
a large number of one particular article instead of
cooperating in the production of a small quantity of many
different articles.
13

Sources of
Comparative
Advantages

Turning from individuals to regions, one finds that the two regions
might be quite differently endowed with facilities for the production
of various articles. One reason is that they are differently supplied
with productive factors. One region may have plenty of iron and coal
but little land for wheat-growing, while another has plenty of wheatgrowing land but a scanty supply of mineral resources; clearly the
former is better adapt to iron production and less well adapt to
wheat-growing than the latter.

It is the proportion of the factors in a region that

determines its fitness for specific industry.

14

Australia has more agricultural land

but less labor, and capital, and mines
than Great Britain; consequently,
Australia is better adapted to the
production of goods that require great
quantities of agricultural land,
whereas Great Britain has an
advantage in the production of goods
requiring considerable quantities of
other factors.

Australia vs Great
Britain
15

Nature of a countrys factor endowment and

its Comparative Advantages

The nature of a countrys factor endowment determines the

method of production and then the relative price of production
factors and consequently the relative costs of products and at
last the comparative advantages of a particular country.

Relatively abundant factor extensive method of employment

relatively low price of this factor price of the goods
requiring relatively large proportions of the abundant factor
would be relatively low.
Relatively scarce factor intensive method of employment
relatively high price of this factor price of the goods
requiring relatively large proportions of the scarce factor would
be relatively high.

16

In brief, each region is best equipped

to produce the goods that require large
proportions of the factors relatively
abundant there; it is least fit to produce
goods that require large proportions of
factors existing within its borders in
small quantities or not at all. Clearly,
this is the cause of interregional trade,
just as varying individual abilities is
cause of individual exchanges.

17

Case of Australia
Australia has an abundant supply of agricultural land
but a scanty population. Land is cheap and wages are
high in comparison with most other countries;
therefore, production of goods that require vast areas
of land but little labor is cheap. This is the case with
wool, for example. Sheep-raising requires great areas
of land but little labor, and the shearing is a relatively
simple process; hence, wool can be produced at a
lower cost than in countries where land is expensive,
even if wages in the other countries are somewhat
lower than in Australia. Similarly, regions with an
abundant supply of labor, technically trained as well
as unskilled, and of capital will find it profitable to
specialize in manufactures, for labor is cheaper in
such regions than in Australia.
18

kangaroo

rangeland

The conclusion follows that each

region has an advantage in
production of commodities into
which enter considerable amounts
of factors abundant and cheap in
that region

Brief Summary

Countries differ in their

relative stocks of the
different factors of
production, these differential
factor supplies influence the
costs of producing particular
goods. Differences in
production costs lead to the
comparative advantages of a
country in international trade.
A country with an abundant
supply of capital and little
labor, and therefore has a
comparative advantage in
and exports such capitalintensive goods.

19

Prominent Characteristics

of the Theory
Factor Endowment Theory of Heckscher and
Ohlin has a prominent characteristic which
obviously separate itself from trade theory so
far of the older generations of economists.

20

Clearing off the Labor

Value Theory
Marxist political economy revealed
the law of capital accumulation and
became an ideological weapon of
proletarian to fight against the
capitalist exploitation. It is necessary
for the so-called main trend
economics to eliminate influences of
Marxism.
At first, the prominent characteristics of factor
endowment theory is to clear off the labor value
theory in analysis of the basis of trade. This
development represents the tendency of
vulgarization of economics in field of trade
theory. Ultimately to treat living labor as only
one of the factors just like capital and the other
materials is hard to be understood as a progress.
21
Where could we
see the human rights?

Lay Comparative Advantages on a New Foundation

The arduous task of Heckscher and Ohlin is to establish a real
foundation for comparative advantages. How did they do that?
They both agreed that mutually
beneficiary trade comes from the
respective comparative advantages
of the trade partners. But they only
took comparative advantages as an
existing prerequisite. At the
mention of sources of comparative
advantages they argued that they
could be only derived from the
naturally constituted factor
endowment, the Gifts of the
Nature .
22

Some Comments on
Factor Endowment Theory

Factor endowment theory breaks away from the

classical labor value theory and tries to explain the
reason of international trade in an entirely new way.
Heckscher-Ohlin theory holds that comparative
advantages enjoyed by different countries are the prerequisite of trade. These comparative advantages,
however, do not come from the relative differences in
labor inputs of production as the classical economists
described.
It is the differences in a countrys production factor
endowment that determines the production costs of
different countries and thus their respective
comparative advantages in international trade.
23

That is to say it is factor endowment theory not labor

value theory that functions as the foundation for
international trade.
This implies that comparative advantages and thus
international trade do not related with labor at all. The
very important comparative advantages are only the gifts
of the nature.
The basis of trade says good-bye to the labor value
theory. This sort of theoretical development suits the need
of bourgeois economics to negate the labor value theory
since the theory functioned as the theoretical basis of
Karl Marxs political economy theory, which concluded
the ending of the capitalist system and springing up of the
communist system.
24

Theoretical
Position of H-O
Since Heckscher and Ohlin opened up a new path and
Theory
established a so-called
reasonable theoretical approach

of explaining and analyzing issues of international trade

their theory had been widely accepted in the academic
circles in the western world and had taken the position
of the orthodox or the main trend of trade theory.(
)
Therefore, factor endowment theory could be
appropriately evaluated as a theoretic milestone in
development of trade theory. Consequently, it has
become the important theoretical origin of the so-called
new trade theories developed in the past several
decades.
25

The H-O-S Model

The basic idea of factor endowment theory has been much

refined and explored in the past several decades, in
particular in a most famous series of papers by Paul
Samuelson, W. Stolper, T. Rybczynski, and so on.
Particularly, P. Samuelson published International Trade
and the Equalization of Factor Prices (1948) and
International Factor-Price Equalization Once
Again(1949), the latter had been included in Readings in
International Economics (1968) edited by American
Economic Association.
Samuelson systematically proved the basic principle of
factor endowment theory by a rigorous mathematical
approach and introduced his contributive ideas about the
theory. Therefore, factor endowment theory is sometimes
known as Heckscher-Ohlin-Samuelson Model or H-O-S
Model
26

Several Theoretical Assumptions

of the Theory

The extended trade model

Constant supply of productive factors
Countries differ from each other only in
factor endowment
No technical progress and no changes of
returns in scale
27

The extended trade model

That is the so-called two country-two factor-two good model

( 222 model ). The model could be used to illustrate trade between
the two countries when they produce two commodities by using two
sorts of production factors.
It holds that the two sorts of production factors and the two
commodities are assumed to be homogeneous, respectively. That is to
say no attention would be put on the influences of different qualities of
the production factors and goods produced.
The two trade partners would be assumed differently endowed with
production factors while the two goods would be assumed with
different factor intensities. In addition trade would be assumed to be
executed under the barter trade system.
If we define the two sorts of factors as capital and labor, in this model,
it is assumed that one country endows relatively abundant labor but
relatively scant capital while the other country has a relatively
abundant stock of capital but labor is of relative scarcity. Further
more, one commodity is assumed to be labor-intensive while the other
commodity capital-intensive. At last, barter trade would be carried out.
No money used in trade for simplifying
the analysis.
28

Constant supply of production factors

That implies the variations in a countrys natural

endowment of production factors would be disregarded.
In addition, factors of production are internationally
completely immobile but intra-nationally freely mobile.
With this assumption the unique factor price would be
reached in one countrys domestic market for production
factors. Because each countrys production factors and
commodity market are assumed perfectly competitive the
total amount of all sorts of factors of production could be
fully employed.
That means the two countries can both realize one of the
macroeconomic goals, full employment of production
factors.
29

Countries differ from each other

only in factor endowment

The two countries are as the same as each other in

almost every respect except their factor endowment. It
follows that the same production techniques would be
applied to produce the two commodities.
Or equivalently speaking, the two countries have the
same production functions of the two commodities.
Furthermore, propensity to consume in one country is
as the same as that in the other country.
The same propensity to consume implies that
consumption proportion of the two goods does not
differ in the two countries when prices of the two
commodities are given.
30

No technical progress and

no changes of returns in scale

Constant Production techniques means the impact of

technical progress on trade patterns will not be
considered.
Thus people can analyze respective comparative
advantages of different countries exclusively derived
from differences in factor endowments and trade
patterns on the basis of such differences.
The assumption of that returns in scale do not change
in line with variations in production scale indicates that
certain percentage of changes in input of production
factors will lead to the same percentage of changes in
the output produced.
That means No diminishing returns of scale.
31

Brief summary of the assumptions

From the above theoretical assumptions of the theory we can

easily see that the essential difference between the theory and
other trade theories is that it inserts a new element into its trade
model.
That is factor of production. The former 22 model has been
changed into the so-called 222 model. By adding this
element into trade model Heckscher and Ohlin successfully laid
the basis of trade on different factor endowments of the countries
participating international exchanges.
In this 222 model, for instance the two countries, A and B,
are producing and exchanging two goods, F and C, by using two
sorts of production factors, L and K.
In this model, if we say country A has a relatively abundant supply
of labor and a relatively scant endowment of capital. It is
equivalent to say that country B is relatively rich in capital
endowment and it is relatively scantly supplied with labor.
Similarly, in this model if Good F is labor-intensive that implies
Good C is capital-intensive.
32

Two important theoretical problems

To correctly understand the essentialities of factor

endowment theory two important theoretical problems
must be resolved in advance.
Problem One: How to define the factor abundance
or scarcity of a country?

Problem Two: How to define factor intensities of

different goods?

33

How to define the factor abundance

or scarcity of a country?

Physical definition
A country is relatively labor abundant and capital
scarce because , in this country than in its trade
partner, more labor are allocated with certain
amount of capital, or less capital are allocated with
certain quantity of labor.
Conversely, if relatively more capital could be
allocated with certain quantity of labor, or less labor
are allocated with certain amount of capital, in a
country than in its trade partner, this country is a
capital abundant and labor scarce country.
It is very obvious that the so-called physical
definition is actually a comparison between the
capital/labor ratios, or the labor/capital ratios of the
two countries.
34

Lets use K and L stands respectively

for capital and labor. In a two-country
two-factor and two-good model,
( K/L ) a ( K/L ) b ,
or ( L/K ) a ( L/K ) b
Country A is a labor abundant and a
capital scarce country relative to
Country B. Or equivalently, Country B
is a capital abundant and a labor
scarce country relative to Country A.

35

The K/L ratio is a

very important
criterion of defining
basic nature of a
countrys factor
endowment.

Economic definition

Sometimes, economic definition can also be termed as

price definition .
As we know factor endowment of a country determines
the techniques to use the factors of production, extensive
or intensive.
Consequently, factor prices will be much different
between the different countries with different factor
endowment.
In the trade model price of labor will be relatively low
while price of capital relatively high in a labor abundant
and capital scarce country.
In the other country, the labor scarce and capital
abundant one, price of labor will be relatively high
while price of capital relatively low.
36

If we use I and W for price of capital, interest, and price of labor,

wage rate, respectively, we could have another definition of a
countrys factor endowment. That is the ratio between prices of the
two sorts of factors (for simplicity, we use the term factor price
ratio, FPR).
That implies the so-called economic definition is actually a
comparison between different FPRs in different countries.
In a two-country two-factor and two-good model,
( W/I ) a ( W/I ) b , or ( I/W ) a ( I/W ) b
Country A is a labor abundant and a capital scarce country
relative to Country B. Or equ8valently, Country B is a capital
abundant and a labor scarce country relative to Country A.

37

Problem Two: How to define factor intensities

of different goods?

The basic assumption of homogeneous production techniques in

the two countries holds that the two countries produce the two
kinds of goods, F and C, in particular production functions.
It is supposed that respective production functions of Good F and
Good C are as the followings:
F = f ( 8K, 4L ), while C = f ( 6K, 2L )
Or equivalently, the two countries are using the same production
techniques to produce the two goods and factor proportions in
production of Good F and Good C are as the followings:
1F = 8K + 4L (8 units of K and 4 units of L should be employed to
produce 1 unit of Good F)
1C = 6K + 2L (6 units of K and 2 units of L should be employed to
produce 1 unit of Good C)
38

From the above production functions it is obvious that for

producing one unit of Good F more capital and more
labor should be employed than to produce one unit of
Good C.
But we can say nothing about factor intensities of Good F
and Good C only by comparing the absolute quantities of
K and L in producing certain amount of them. Otherwise,
we could fall into a theoretical paradox.
However, if we compare the relative factor inputs, in
other words factor proportions of production functions,
that is how to combine the two factors in production
process we can find out that proportions of factor
employment or relative ratio of factor input in producing
Good F clearly differs from that in Good C.

( K / L) F ( K / L) C

( L / K ) F ( L / K )C
39

In producing 1 unit of Good F, 2K are equipped for 1L, in other

words 1L is equipped with 2K. In production process of Good C
this number is 3. Three units of capital must be allocated for 1
unit of labor. That means more K should be allocated for certain
labor input in producing C than F.
Equivalently, in producing 1F, 1/2 L used for 1K, in other words
for using 1K a half L must be employed with the given production
technique. While in producing 1C, for 1K, 1/3 labor is enough.
Consequently, we say Good F is a L-intensive good relative to
Good C while Good C is a K-intensive good relative to Good F.
Therefore, comparison of relative ratios of factor input in
producing different goods serves as the only definition of factor
intensity of particular commodity.

( K / L) F

(L / K )F

( K / L) C

(L / K )

Good F is relatively labor intensive

Good C is relatively Capital intensive.

40

Theorems of the Factor Endowment Theory

Heckscher-Ohlin
Theorem
Basic
Theorems
Factor
Endowment
Theory
Extensive
Theorems

Factor Price
Equalization
Theorem
StolperSamuelson
Theorem
Rybczynski
Theorem

The factor endowment theory has four theorems. They are two
basic theorems and the other two extensive theorems.
41

Heckscher-Ohlin Theorem

Heckscher-Ohlin Theorem can be summarized as the followings:

Comparative advantages of different countries serve as the basis of
trade. Such comparative advantages come from the differences in
their factor endowments. Therefore, different factor endowments
among countries are the real cause of international trade.
Consequently, a country has its comparative advantage in
production of that good in which its relatively abundant factor is
relatively intensively used.
That is to say a country with a relatively abundant labor
endowment and a relatively scarce capital endowment, thus its W/I
ratios is relatively low, has comparative advantages in production
of L-intensive good.
Meanwhile, a country with a relatively abundant capital
endowment and a relatively scarce labor, thus its W/I ratios is
relatively high, has its comparative advantages in production of Kintensive good.
42

The respective comparative advantages determine

production and trade structures of the two countries.
In accordance with their respective comparative advantages the
former should concentrate its productive factors on production of Lintensive goods and export these goods to exchange for K-intensive
goods from the latter.
Conversely, for the same token, the latter should concentrate its
productive factors on production of K-intensive goods and export
these goods to exchange for L-intensive goods from the former.
By doing so the two countries can bring their respective
comparative advantages into a full play and obtain trade benefits.

43

Factor Price equalization theorem

Price equalization theorem can be summarized as the followings:

A perfectly free trade between two countries will lead to a tendency
of equalization of factor prices in them. If the two countries both
practice a incomplete international specialization of production
( ), i.e. they are both producing the two
sorts of goods, the ultimate result of free trade must be an exact
equalization of factor prices in the two countries. Such an
equalization of factor prices could substitute, to some extent,
functions of mobilization of factors of production between the two
countries.

Factor price equalization theorem illustrates the function of price

mechanism in the case of international trade. In a 222 model,
according to Heckscher-Ohlin theorem, a L-abundant country
has a relatively lower W/I ratio and thus it must export Lintensive goods and import K-intensive goods. Otherwise the
countrys comparative advantages could not be brought into full
play and the country could not enjoy economic benefit from free
trade.
44

Taking specific assumptions, trade will cause changes in factor

prices in factor market.
At the same time, however, assumptions are held that factor endowments of the
two countries are constant indicating the aggregate supply of production
factors would not change.

It is also assumed that price of production factors must be determined by

supply-demand relations in a perfectly competitive factor market.

Therefore, in line with trade, L-abundant Country As domestic production scale

of L-intensive goods increases and that of K-intensive goods decreases.

Thus in its domestic factor market demand for L will be relatively larger while
demand for K will be relatively smaller.

Taking a constant factor supply price of labor tends to increase and price of
capital tends to fall.
(W/I)b

The opposite development will be in Country B.

Wa increase while
(W/I)a rises
Trade based
Ia decreases.
(W/I)i
on factor
Wb decreass while
(W/I)b falls
endowment
Ib increases.

45

(W/I)a

Another function of trade will lead to such relative

variations in factor prices in the two countries.
In addition, when this L-abundant country exports its L-intensive goods and
imports K-intensive goods from its trade partner it is actually exporting its
abundant labor which is embodied in its L-intensive exportable goods in a
relatively larger proportion while its scarce capital, embodied in a relatively
larger proportion in K-intensive imports, is introduced from abroad.
Consequently, the degree of L-intensity and K-scarcity of this Country will
necessarily decrease. The opposite development happens in its trade partners
economy.
So we see another function of trade: Trade will substitute factor movement
between two countries, to some extent. In other words, trade, movement of
commodities, can be concluded as movement of factors in another form.
Such effect of trade lead to the relative variations in factor prices in the two
countries and ultimately results in factor price equalization between them.
(W/I)a

(W/I)i
46

(W/I)b

Ohlins conclusion
on Factor Price Equalization Theorem

The effect of interregional trade is a tendency toward

equalization of prices of productive factors.
From each region goods containing a large proportion of
relatively abundant and cheap factors are exported, and
these factors therefore become scarcer than before,
whereas, goods containing a large proportion of scarce
factors are imported, and the latter factors therefore
become less scarce.
The same result could be obtained by a transfer of the
factors.
As it is, interregional trade serves as a substitute for
such interregional factor movements.
47

Samuelsons Conclusion
on Factor Price Equalization Theorem

Paul Anthony Samuelson proved the basic principle of factor

endowment theory. He concluded in his famous paper
International Factor-Price Equalization Once Again
published in June 1949 that factor price equalization is not just
a tendency but the two exchanging nations would experience a
complete factor-price equalization.
The complete factor-price equalization will invariably influence
the behavior of the rational producers in the two countries and,
at last, leads to the readjustment of factor proportions. But such
readjustment will not change the basic factor nature of factor
intensities of the two goods.

Any producer must closely follow the law of economic

efficiency. It is this law that makes such readjustment
necessary.
48

Principle of Profit Maximization and Cost Minimization

In the figure, we have an Isocost Line and
several Isoquet Curves. OP is Production
Expansion Line showing increases in
production. The tangency of Isocost Line
is actually W/I Ratio. Tangency of
Isoquent Curve is really MPL/MPK.

The Law of Economic Efficiency indicates

that the product that could be produced by
the last unit of input must equals the cost
of the last unit of input.
In other words Marginal Product equals
Marginal Cost, MP MC.

49

On Point E , the tangent point

between Isocost Line and Isoquent
Curve I1, the tangency of Isocost
Line (W/I ) equals the tangence of
Isoquent Curve I1 (MPL/MPK). In
this sense, we conclude that only
such tangent point represents the
most efficient production decision to
meet the requirement of the Law of
Economic Efficiency.

Pre-trade and post-trade Production Decisions

In order to meet requirement of profit maximization and cost minimization, The

two countries readjust their production decisions after trade because of changes
in factor prices, from a to a and from b to b, respectively. However, such
readjustment does not change the relative factor intensities of the two goods.
Comparing the post-trade production decisions, a and b, we see F is still
relatively labor intensive than C. In addition we also see a tendency of factor
price equalization between the two countries.
50

Stolper-Samuelson Theorem ( )
W. F. Stolper and P. A. Samuelson published a
famous research paper: Protection and Real
Wages in Review of Economics Studies in
November 1941. In this paper they analyzed the
impact of tariff and the other trade protection
measures on trade and distribution of income.
They started their analysis with the assumption that a L-abundant
country will adopt particular protection measures such as import
tariff to protect its domestic K-intensive industry. Such protection will
lead to increase price of K-intensive Good C in its domestic market.
Under the barter system the relative price of Good C in terms of
Good F increases and the relative price of Good F in terms of Good
C decrease.
51

Effects of Trade Protection

As trade protection develops, to some extent, to produce Good C

would be more profitable.
Provided that production factors are domestically freely mobile
some factors employed in producing Good F, including K and L,
would be induced to enter into C industry holding the assumption
of full employment of production factors.
The output of Good F reduces and more Good C will be produced.
The key point now is that factor movement from F industry to C
industry must be carried out strictly following the particular
production functions of the two industries taking production
techniques constant.
That means factors are proportionally removed from F industry in
accordance with production function of Good F and they are also
proportionally absorbed by C industry also according to
production function of Good C. 52

Factor movement and changes in FPR

Giving the previously assumed production functions

F = f ( 8K, 4L ); C = f ( 6K, 2L )
Or 1F = 8K + 4L; 1C = 6K + 2L
If production of Good C increases by 2 units, the additional K and
L inputs in C industry will be 12K and 4L, respectively.
For the same token, reducing output of Good F by 1 unit 8K and
4L will be released.
Considering supply-demand relations in factor market we see that
labor market is in equilibrium while demand exceeds supply in
capital market.
Non-equilibrium in capital market pushes price of capital to
increase. Taking price of labor unchanged FPR, W/I, falls down.
53

Factor movement and changes in FPR

In order to offer more K for the extension of production of Good C

production scale of Good F must be further reduced.
For instance that 1.5 units of Good F are decreased and thus 12K
and 6L will be released. The released capital could meet the
additional requirement of increasing production of C industry but
2L should not be employed since only 4L are required by C
industry.
That implies while capital market is in equilibrium supply of labor
exceeds demand for it.
Non-equilibrium in labor market results in decrease of price of
labor. Taking price of capital unchanged, FPR, W/I, falls down
again.
It is obviously concluded that protection policies will greatly
influence distribution of income among the owners of different
production factors.
54

How does import tariff protection

affect income distribution
Import Tariff
Protection
on Good C

Pc increase
while Pf
decreases.

Taking the
assumption
of factor full
employment

It is more
profitable to
produce the
protected good.

production
functions
must be
strictly
followed.

I rises while
W falls

S<D in K market
while S>D in L
market.

Factor movement
from Industry F
to Industry C
55

Output of Good
C increases
while output of
Good F
decreases.

Owners of K
take more
while owners
of L loss in
income
distribution.

No Good for Development of Trade

Changes in relative price of one good

in terms of the other derived from
protection policies must have impacts
on trade of a country.
In the above instance the country
would have comparative advantages
in F industry since it is Labundant
country and thus it will export Lintensive Good F while import Kintensive Good C.
Implementing protection policies its
domestic production of Good F
reduces and that of Good C increases.
This countrys willingness of
participating trade must be dammed
other things constant.
That means protection policies are no
good for development of trade.
56

Reasons in Depth of Different Trade Policies

Combining Stolper-Samuelson Theorem with Heckscher-Ohlin

Theorem we can observe in depth the economic doctrine behind
particular trade policies, free trade vs. trade protection, adopted
by particular countries in certain historic stages or by particular
interest groups in a given country.
Generally speaking those countries enjoying some comparative
advantages firmly support free trade policies while the other
countries being comparatively disadvantageous advocate
protection policies.
The interest groups whose industries are comparatively
advantageous hold high the banner of free trade while the other
interest groups whose industries are comparatively
disadvantageous insist to take possible protectionist measures.
57

Rybczynski Theorem

A British economist T. M. Rybczynski published his research

paper, Factor Endowment and Relative Commodity Prices, in
Economica, November 1955.
In this paper Rybczynski analyzed relations between variations
in factor supply and trade equilibrium in a small country
model by using the famous Edgeworth Box introduced by
another respective British economist, F. Y. Edgeworth.
Rybczynskis research changed one of the basic assumptions of
factor endowment theory, supply of production factors are
constant.
In this sense, what Rybczynski did was a new exploration of
factor endowment theory.
58

Conclusions of Rybczynski Theorem

There are two basic conclusions of the theorem:

(1) With the given factor proportion of production in a small
country model when talking about only two sorts of factors
increase in a particular factor supply causes production of
commodity intensively embodied that sort of factor to
increase in an even larger extent and production of the other
factor-intensive commodity absolutely decreases.
(2) When a countrys abundant factor supply increases its
terms of trade will be deteriorated while a country increases
its scarce factor supply will cause improvement of its terms of
trade.
59

Edgeworth Box

In an autarky economy when two

sorts of factors are used to
produce two kinds of goods, each
of them is of a particular factor
intensity, the optimum factor
allocation requires: (1) full
employment of production factors
and (2) factors are allocated in
such a way that it is impossible to
increase output of one good
without decreasing output of the
other good.
In an Edgeworth Box, only those
tangent points between Isoquent
Curves, respectively representing
giving output production of
particular good, stand for the
optimum allocation of production
factors.

A rational producer must behave

strictly following the Law of Economic
Efficiency. That indicates a country
most efficiently produces the two
goods only when the ratio between
marginal product of labor and capital
in producing the two goods are
exactly equal to each other.

60

On those tangent points

( MPL / MPK )F = ( MPL / MPK )C

61

Impacts of labor supply

increases in a labor-abundant
country.

A labor abundant Country H and a

capital abundant Country F to
produce labor-intensive Good U and
capital-intensive Good V.
Suppose that labor supply in Country H
increases. Taking other things constant,
the relative variations of its domestic
production structure lead to changes in
its trade structure.
Exports of its labor-intensive Good F
increases while its imports of Country
Vs capital-intensive Good C increases
at the same time.
OH curve moves outward to OH .
Trade equilibrium point changes
from E to E. Its terms of trade
deteriorated from OT to OT.
62

Immiserizing Growth in a large country model

Y

C0
C1

U0
U1

N1

B
N0

P0
O

63

P1
X

Questions and Problems

Briefly describe the basic doctrine of factor endowment theory.

What is the cause of trade in accordance with factor endowment theory? How to
understand the linkage and difference between the classical trade theory and
factor endowment theory?
How can we correctly conclude a countrys factor endowment and factor
intensity of a given product? Try to raise an example to illustrate the application
of the two definitions, physical and economic?
Try to illustrate the basic meaning of Heckscher-Ohlin Theorem in a
graphical manner.
Why will trade ultimately lead to equalization of factor prices in the two trade
partners?
Try to reveal the economic background of different trade policies taken by
different interest groups of a country or by different countries in the same period.
Why dose a specific country take different trade policies in different periods?
Try to graphically illustrate basic ideas of Rybczynski Theorem and the effect
of changes in a countrys factor supply on terms of trade.
64