The Heckscher-Ohlin Model:

Features, Flaws, and Fixes

I: What's the H-O Model
Like?
Alan V. Deardorff
University of Michigan

Themes of the 3 Lectures

The HO Model is largely well behaved in 2
dimensions, even when you include trade
costs
In higher dimensions, it is not so well
behaved, especially when you include
trade costs
Various modifications and extensions of
the HO model offer some promise of
making it behave better
Nottingham I

Outline of Lecture I
Overview of the H-O Model
The 22 Model
Without trade costs
With trade costs

The 222 Model

Conclusions from the 22(2) Model

Nottingham I

H-O Overview
The Heckscher-Ohlin (H-O) Model Assumptions
Homogeneous goods and factors
Perfectly competitive market equilibrium throughout
(goods and factors)
Production functions
Constant returns to scale
Non-joint

Factors
Perfectly mobile across industries
Perfectly immobile across countries

Countries differ in factor endowments

Industries differ in factor intensities
Nottingham I

H-O Overview
The Heckscher-Ohlin (H-O) Model Implications
Countries export goods that use intensively their
abundant factors (H-O Thm)
Trade draws factor prices closer together across
countries, becoming equal in certain circumstances
(FPE Thm)
Trade changes real factor prices (S-S Thm)
Benefiting owners of abundant factors
Hurting owners of scarce factors

Rybczynski Thm (output effects of factor

accumulation)
Nottingham I

The Textbook 22 H-O Model

Goods X, Y
Factors K, L
X is K-intensive
Goods are final goods
Trade is
Free and frictionless, or
Subject to simple, constant trade costs per
unit (perhaps iceberg)
Nottingham I

The Textbook 22 H-O Model

Analysis: Expanded Lerner Diagram
shows
Production
Factor allocations
Factor Prices
Trade

for given
Goods prices
Factor endowments

Thus
Full solution for
small open
economy
Dependence on
prices for large
economy
Nottingham I

Lerner Diagram

1/wK0

X=1/P

Y=1/P Y

1/wL0

Nottingham I

Lerner Diagram

1/wK0

X0

E0

X=1/P

Y0

Y=1/P Y

1/wL0

Nottingham I

Lerner Diagram
Export

1/wK0

X=1/P

E0

X0

EC = EW

XC
YC
Y0

Y=1/P Y
Import
1/wL0
Nottingham I

10

The Textbook 22 H-O Model

Behavior
If Endowments inside Diversification Cone
Both goods produced
Factor prices independent of endowments

If Endowments outside Diversification Cone

One good produced
Factor prices depend on endowments

Nottingham I

11

The Textbook 22 H-O Model

Sensitivity
All variables (outputs, trade, factor prices) are
uniquely determined and depend smoothly on
Endowments
Prices

Adding trade costs vis a vis a single other

country
Creates range of world prices for which country
does not trade
Outside that range, all variables depend smoothly
on trade costs
Nottingham I

12

The Textbook 22 H-O Model

Summary
With free and frictionless trade:

S I S I ( E K , E L , PX / PY ),

I X ,Y

DI DI ( E K , E L , PX / PY ),

I X ,Y

TI ( S I DI ) TI ( E K , E L , PX / PY ), I X , Y
wJ w j ( E K , E L , PX , PY ),

Nottingham I

J K, L

13

The Textbook 22 H-O Model

Summary
With iceberg trade costs, t:

S I S I ( E K , EL , PX / PY , t X , tY ),

I X ,Y

DI DI ( EK , EL , PX / PY , t X , tY ),

I X ,Y

TI ( S I DI ) TI ( EK , EL , PX / PY , t X , tY ), I X , Y
wJ w j ( EK , E L , PX , PY , t X , tY ),

Nottingham I

J K, L

14

Effects of Increasing Capital

Endowment, EK
K

1/wK0

X=1/P

EK

cone
0

Y=1/P Y

1/wL0

Nottingham I

15

Effects of Increasing EK
SX
SX

Rybczynski Thm: SX/EK,

rises with EK
EK

cone
Nottingham I

16

Effects of Increasing EK
SY

SY

Rybczynski Thm: SY Falls

with EK
EK

cone
Nottingham I

17

Effects of Increasing EK
DX, DY

DX
DY

EK

cone
Nottingham I

18

Effects of Increasing EK
TX, TY
TX

EK

TY
cone
Nottingham I

19

Effects of Increasing EK
wK
wK0

wK
EK

wL

wL

wL0

EK

cone
Nottingham I

20

Effects of Increasing Labor

Endowment, EL

1/wK0

X=1/P

Y=1/P

1/wL0

0
Y

Effects are
mirror image of
increasing EK

EL
L

Nottingham I

21

Effects of Increasing Price of X, PX

1/wK0

X=1/P

Y=1/P Y

1/wL0

Nottingham I

22

Effects of Increasing Price of X, PX

1/wK0

X=1/P

Y=1/P Y

1/wL0

Nottingham I

23

Effects of Increasing Price of X, PX

1/wK0

X=1/P

Y=1/P Y

1/wL0

Nottingham I

24

Effects of Increasing Price of X, PX

SX
SX

PX

(cone)
Nottingham I

25

Effects of Increasing Price of X, PX

SY

SY
PX

(cone)
Nottingham I

26

Effects of Increasing Price of X, PX

DX, DY
DY

DX
PX

(cone)
Nottingham I

27

Effects of Increasing Price of X, PX

TX, TY

TX

PX
TY

(cone)
Nottingham I

28

Effects of Increasing Price of X, PX

wK

wK

Stolper-Samuelson Thm:
wK/PX, wK/PY rise with PX

PX

(cone)
Nottingham I

29

Effects of Increasing Price of X, PX

Stolper-Samuelson Thm:
wL/PX, wL/PY fall with PX

wL

wL

PX

(cone)
Nottingham I

30

Effects of Increasing Price of Y, PY

Effects are mirror image of increasing P X

Nottingham I

31

Effects of Presence of Trade Costs

Assume iceberg trade cost t1>0, equals
fraction of each good that disappears in transit to
world market (must ship t for 1 to arrive)
Implication for domestic prices if world prices are
PXw, PYw:
If country exports X: PX=PXw/t; PY=tPYw
If country exports Y: PY=PYw/t; PX=tPXw
If country does not trade:
(PXw/PYw)/t2 PX/PY t2(PXw/PYw)
Nottingham I

32

Presence of Trade Costs

1/wKw

X=1/PXw

EC

Y=1/PYw
1/wLw

Nottingham I

33

Presence of Trade Costs

1/wKw

X=1/PXw

If country exports X
which it will if endowment
is above this line
ECX
EC

Y=1/PYw
1/wLw

Nottingham I

34

Presence of Trade Costs

1/wKw

X=1/PXw

EC
ECY
If country exports Y
which it will if endowment
is below this line
Y=1/PYw
1/wLw
L
Nottingham I

35

Presence of Trade Costs

If country exports X

1/wKw

X=1/PXw

autarky
ECX
EC
ECY
If country exports Y
Y=1/PYw
1/wLw

Nottingham I

36

Effects of Increasing EK in Presence

of Trade Costs
If country exports X

1/wKw

X=1/PXw

autarky
ECX
EC
ECY
If country exports Y
Y=1/PYw
1/wLw

Nottingham I

37

Effects of Increasing EK in Presence

of
Trade
Costs
P /P
X

autarky

t2PXw/PYw

PXw/PYwt2

Y-export X-export
cone
cone
Nottingham I

EK
38

Effects of Increasing EK in Presence

of
Trade
Costs
S
X

autarky

Y-export X-export
cone
cone
Nottingham I

EK
39

Effects of Increasing EK in Presence

of
Trade
Costs
S
Y

autarky

Y-export X-export
cone
cone
Nottingham I

EK
40

Effects of Increasing EK in Presence

of Trade Costs
TX, TY

autarky

TX

EK
TY

Y-export X-export
cone
cone
Nottingham I

41

Effects of Increasing EK in Presence

of Trade
Costs
autarky
wK

wK
EK
wL

wL

Y-export X-export
cone
cone
Nottingham I

EK
42

Effects of Increasing PXw/PYw in

Presence
of
Trade
Costs
S ,S
X

autarky

SX

(A =PXA/PYA =
autarky price)

SY

Y-export X-export
cone
cone
Nottingham I

w =PXw/PYw
43

Effects of Increasing PXw/PYw in

Presence
of
Trade
Costs
D ,D
X

autarky

A
Y-export X-export
cone
cone
Nottingham I

DY

DX
w =PXw/PYw
44

Effects of Increasing PXw/PYw in

Presence
of
Trade
Costs
T ,T
X

autarky

TX

w =PXw/PYw
TY

Y-export X-export
cone
cone
Nottingham I

45

Effects of Increasing PXw/PYw in

Presence
of
Trade
Costs
w /P
K

autarky

wK/PY

A
Y-export X-export
cone
cone
Nottingham I

w =PXw/PYw
46

Effects of Increasing PXw/PYw in

Presence
of
Trade
Costs
w /P
L

autarky

wL/PY
A
Y-export X-export
cone
cone
Nottingham I

w =PXw/PYw
47

Effects of Increasing Trade Costs

As trade cost, t, rises from zero, Y-export
cone and the X-export cone move further
apart, and the autarky range of factor
endowments and world prices gets larger
For any given endowment and world
prices, a rise in t reduces the volume of
trade and moves other variables in the
direction of their autarky values.
Nottingham I

48

Effects of Increasing Trade Costs

Example:
Consider a country whose factor endowments
have it completely specialized in good X at
world prices

Nottingham I

49

Effects of Increasing Trade Costs:

Example
SX,SY

autarky

SX
SY

X-export
cone

t
Nottingham I

50

The World Market:

The Textbook 222 H-O Model
To model the world economy, add a second
country (country *)
Solve for world (relative) price that clears the
world market

TX ( E K , EL , PX / PY ) T ( E , E , PX / PY )
*
X

Nottingham I

*
K

*
L

51

The World Market:

The Textbook 222 H-O Model
Results
S I S I ( EK , E L , EK* , EL* ),

I X ,Y

DI DI ( EK , EL , EK* , EL* ),

I X ,Y

TI TI ( EK , EL , EK* , EL* ),

I X ,Y

wJ w j ( EK , EL , E K* , EL* , PY ), J K , L

with analogous expressions for the other

country

Nottingham I

52

The World Market:

The Textbook 222 H-O Model
Depictions of world equilibrium
Offer curves (Meade)
Integrated-world-economy diagram (Dixit-Norman)
Sufficient (but not elegant) to use supply and
demand of just one of the goods

Nottingham I

53

World Equilibrium
TX, TX*

TX

PX/PY

(PX/PY)w

TX*

(cone) (cone)*
Nottingham I

54

Conclusions from the

22(2) H-O Model
Equilibria are well defined
Equilibrium quantities are unique
Equilibrium prices are unique up to a
numeraire

Nottingham I

55

Conclusions from the

22(2) H-O Model
Includes three types of equilibria
Autarky (when there are trade costs)
Diversified
Specialized

Determinants of equilibrium type are

mostly clear
Several relationships between variables
depend importantly on type of equilibrium
Nottingham I

56

Conclusions from the

22(2) H-O Model
Classic Theorems are clear and precise
Countries specialize, but only if endowment
differences are large
Prices and quantities vary continuously with
exogenous changes in
Endowments
Trade costs

In particular, trade responds sensibly to

Prices and
Trade costs
Nottingham I

57

Whats Next?
My point in the next lecture will be that
some of these attractive properties are lost
in higher dimensions i.e., especially
when there are more than 2 of goods and
countries

Nottingham I

58