Trade Theory - Heckscher-Ohlin Model
and Beyond
Chapter 3: The Modern Trade Theory – Heckscher-Ohlin Model
Chapter 4: Heckscher-Ohlin and Other Trade Theories
4.1 Heckscher-Ohlin Theory (H-O Theorem)
4.2 Factor Price Equalization and Income Distribution (H-O-S Theorem)
4.3 Empirical Tests of the H-O Theory
4.4 Economies of Scale and International Trade (Perfect Competition)
4.5 Intra-Industry Trade of Differentiated Products (Imperfect Competition)
4.6 Theory of Similar Preferences
4.7 Technological Gap and Product Life Cycle Theory
4.8 Transport Costs, Environmental Standards, and International Trade
4.1 Heckscher-Ohlin Theory (H-O Theorem)
I. Origin of the H-O Theorem
• Proposers: Heckscher & Ohlin (Sweden)
• Works:
- Heckscher: The Effect of Foreign Trade on the Distribution of Income (1919)
- Ohlin: Interregional and International Trade (1933)
Basic Concepts of the H-O Theorem
• Factor Endowments: The relative proportions of production factors a country possesses.
E.g., If country A has a higher capital-to-labor ratio (K/L) than country B, then A is capital-
abundant, B is labor-abundant.
• Factor Intensity: The relative proportions of factors used to produce a good. If good X uses
more capital relative to labor than good Y, then X is capital-intensive.
• Principle: Each country exports the good that uses its abundant and cheap factor
intensively, and imports the good that uses its scarce and expensive factor intensively.
Theoretical Framework of the H-O Theorem
1. Price differences in goods drive trade.
2. Goods prices are determined by factor prices and technology.
3. Factor prices are set by supply and demand.
4. Factor demand is derived from final demand for goods.
5. Final demand depends on income distribution and preferences.
Formal H-O Model
If Pa < Pa’, then Country A has a comparative advantage in good X, Country B in good Y.
Trade improves both countries’ welfare.
4.2 Factor Price Equalization and Income Distribution
• Stolper-Samuelson Theorem: An increase in the price of a good raises the real income of
the factor used intensively in its production, and reduces the real income of the other factor.
• H-O-S Theorem: International trade equalizes factor prices across countries by
substituting for factor mobility.
4.3 Empirical Tests: The Leontief Paradox
• Leontief (1951) used 1947 U.S. input-output data to test H-O Theory.
• Found that U.S. exports were labor-intensive while imports were capital-intensive—
opposite of expectations.
• Explanations include human capital differences, trade barriers, and demand reversals.
4.4 Economies of Scale and Trade
• Krugman’s model: Even without comparative advantage, trade arises due to economies of
scale.
• External economies of scale lead to specialization based on historical or accidental factors.
4.5 Intra-Industry Trade under Monopolistic Competition
• Assumes differentiated products and increasing returns to scale.
• Larger markets lower average costs and increase variety.
• Trade benefits countries with similar demand and no tech differences.
4.6 Theory of Similar Preferences (Overlapping Demand)
• Trade is more likely between countries with similar income levels due to overlapping
consumer preferences.
4.7 Technological Gap & Product Life Cycle Theory
• Introduction Phase: Innovation occurs in advanced countries.
• Growth Phase: Export from developed to developing countries.
• Maturity Phase: Developing countries gain advantage and begin exporting standardized
products.
