Ellsworth has more clearly addressed himself to this issue than OhIin, and his discussion is worth reproducing at some length: one might conclude that complete equalization of the price of the various productive factors would result from free commodity trade. The different goods require different factor-proportions for their production. General Equilibrium The H-O model is a general equilibrium model. Leontief found out that the U. Production functions are the same in both countries and they are homogeneous of the first degree. In this way his theory is better and more acceptable than the classical theory of international trade. On the other hand, a labour-abundant country B with a scarcity of capital will have a comparative advantage in specialising in the production of labour-intensive commodities and export some quantities of them and in exchange for import capital-intensive commodities.
But the consumption of the two commodities would be different in the countries. But he did not explain how after all this comparative costs difference arises. Differences in preferences or demands for goods: Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and preferences for goods or, to put it in other words, differences in pattern of demand also give rise to trade between the countries. Suppose there are two countries A and B with same factor-endowments. Hence there are constant returns to the scale.
Columns 2 and 3 denote factor prices in В and A in their respective currencies, rupees and dollars. There are no transport costs. This can be done by translating the factor prices of one region in terms of the other region, in view of the prevailing rate of exchange. It will also be seen from Fig. Assuming a given demand, it follows that a capital-rich country has a cheaper or a lower capital price and a labour-abundant country has a relatively lower labour price. This theory differs from the theories of comparative advantage and absolute advantage since these theory focuses on the productivity of the production process for a particular good. It is worth mentioning here that the pattern of import trade of the developing countries has changed in the last several years and now consists of greater quantity of various forms of capital goods and less of textiles.
The nature of this bias is best illustrated by figure 1. There may be qualitative differences in the different factors in the two regions. Which means more specialisation on capital goods. Alternatively factor abundance can be defined in physical terms. Secondly, even more important than the importation of capital goods is the transmission of technical know-how, skills, managerial talents, entrepreneurship through foreign trade. Possible equilibrium points when the two countries trade are shown in figure 6.
Therefore, the country will be better off importing those goods. Definition A country is capital-abundant relative to another country if it has more capital endowment per labor endowment than the other country. The exports of a product using the abundant factor by a country will cause the demand for that factor to increase and thereby make it relatively less abundant and raise its price. It could only occur if the demand for various kinds of labour could be concentrated largely on those areas where each kind was most abundant, thereby raising wages there to a parity with wages in scarce labour areas. Suppose the terms of trade settled are such that we get tt as the terms of trade line showing the price ratio at which goods can be exchanged between India and the U.
This is also illustrated by the fact that the commodity price line P 1P 1 is steeper than the line P 2P 2. The study showed that the U. Let us take an extreme example. Heckscher and Ohlin explain that international trade is due to the differences in factor-endowments i. It is worth noting that both developed and developing countries have obtained benefits from trade. To the extent these conditions do not exist, factor prices will remain unequal even after trade takes place between the countries. Cost differences are taking place because of the factor price differences in the two countries.
Trade because currencies of different countries are related to each other through foreign exchange rates which determine the value or purchasing power of different currencies. This is because under differences in demand or preferences for goods, the commodity price-ratios would not conform to the cost-ratios based on factor endowments. He found out that U. The flow of trade would continue expanding until the prices of machines in the two countries in the absence of transport costs and tariffs would become equal. The same applies to the price of capital.
But the theory of comparative cost is static, it indicates only those gains which accrue to the trading countries as a result of the differences in given cost of production and given production possibilities of various products at a given point of time. Fourth, as has been pointed out by Prof. Critical Evaluation of Heckscher-Ohlin Theory of International Trade: Heckscher and Ohlin theory has made invaluable contributions to the explanation of international trade. The boxes and contract curves are, of course, the same. These are obviously production patterns which are possible under trade.
It is not true that factor price equalization is highly improbable. Classical trade theory always took it for granted that free mobility of factors of production between different regions would tend to equalize the relative and absolute prices of productive services in the different regions. It is not true that factor price equalization is impossible. The gist of the theory is: what determine trade are differences in factor endowments. It follows from above that some countries have a comparative advantage in the production of a commodity for which the required factors are found in abundance and comparative disadvantage in the production of a commodity for which the required factors are not available in sufficient quantities.
Static gains from trade refer to the increase in utility or welfare of the people of the trading countries as a result of the optimum utilisation of their given factor-endowments, for they specialise on the basis of their comparative costs. By taking both assessments I realized the importance of self-evaluation. Once again we notice that country B, which is a labour surplus country exports capital intensive goods steel and imports labour intensive goods cloth. Since there is wide agreement among modern economists about the explanation of international trade offered by Heckscher and Ohlin this theory is also called modern theory of international trade. I would begin this progress by comparing a then and now technique as my way of observing my own growth. What are the implications for factor prices? Demand conditions are identical in both the countries.