Recall that in the simple Ricardian model only one factor of production, labor, is needed to produce goods and services. Applications of these theorems also allows us to derive some other important implications of the model. The Main Results of the H-O Model There are four main theorems in the H-O model: the Heckscher-Ohlin theorem, the Stolper-Samuelson Theorem, the Rybczynski theorem, and the factor-price equalization theorem. Two such models are Ricardian and Heckscher-Ohlin models. Why should the equalization be only partial and incomplete? Most importantly, the magnification effect allows one to analyze the effects of price changes on real wages and real rents earned by workers and capital owners.
Because the country produces goods based on the resources that they have in abundance, it will be cheapest to produce these goods. Instead Ohlin shared the prize with the British economist James E. The theorem states that if the price of the capital-intensive good rises for whatever reason then the price of capital, the factor used intensively in that industry, will rise, while the wage rate paid to labor will fall. We have discussed that given certain assumptions trade will equalize factor prices. For instance, China produces and exports technology products because the low prices of relevant resources in China provide comparative advantage in producing and exporting this type of products, while Turkey mainly exports clothing products due to the cheaper prices of cotton and advanced textile industry present in Turkey. A movement to free trade will cause the real return of a country's relatively abundant factor to rise, while the real return of the country's relatively scarce factor will fall. Yet, some of the aspects of international trade are still not fully researched and even existing theories related to the international trade need to be submitted to critical analysis taking into account ever-changing global economic environment.
The country that has a lot of capital specializes in the production of cell phones, whereas the country that has more labor specializes in the production of jeans. It is important to note that Heckscher and Ohlin agreed with this fundamental proposition and only elaborated this by explaining the factors which cause differences in comparative costs of commodities between different regions or countries. However, once goods prices are equalized, as they are in free trade, the value of marginal products are also equalized between countries and hence the countries must also share the same wage rates and rental rates. Also, if steel production is capital intensive, then it implies that clothing production must be labor-intensive relative to steel. The different goods require different factor-proportions for their production.
Perhaps it is this which lies behind the empirical findings by Leontief that though America is a capital abundant and labour-scarce country, in the structure of its imports capital-intensive goods are relatively greater whereas in the structure of its exports labour- intensive goods are relatively greater. In a capitalist economy most of the physical capital is owned by individuals and businesses. These countries will trade these goods with each other. . At the same time, the import-competing industry, suffering from falling prices, will want to reduce production to cut its losses. Trade diversion, according to Czinkota et al 2008 is a cost of economic integration to a particular country of being a part of group of countries that trade freely among themselves, but maintain barriers to non-members. The standard H-O model begins by expanding the number of factors of production from one to two.
As production functions are the same in both countries the aa isoquants are identical for both countries. While a map can help us understand an unknown terrain, economic theories help us understand economic interactions between individuals or countries. As a result, if these two countries were not trading initially, i. The Heckscher Ohlin Model is also called the 2x2x2 model, implies that two countries are needed for trade, engaging one another in trade with two goods, and with two homogeneous production factors. Heckscher-Ohlin Theorem: According to Ricardo and other classical economists, international trade is based on differences in comparative costs.
Further, take two countries A and B; in country A capital is relatively abundant and labour is relatively scarce. Therefore, the price of capital is bid up, and the relative price of what was the cheap factor before trade rises. It was the difference in technology that motivated advantageous international trade in the model. The higher prices in the export industry will inspire profit-seeking firms to expand production. Each country has its own natural resources and specialities in the area of production. If production technologies differ across countries, as we assumed in the Ricardian model, then factor prices would not equalize once goods prices equalize. Nevertheless, apart from the serious shortcomings of Heckscher-Ohlin theory, it still fails to explain intra-industry trade between countries, because the theory contradicts to the notion of intra-industry trade in fundamental level.
Gains from trade By specializing in production, and by trading with other countries, it is possible for countries to increase their incomes. The theorem was also generalized by Ronald Jones who constructed a magnification effect for quantities in the context of the H-O model. The reason for the identical technology assumption in the H-O model is perhaps not so much because it is believed that technologies are really the same; although a case can be made for that. But these differences are not such that prevent the occurrence of trade between nations. Any neo-classical model of trade will do. Trade flows will rise until the price of both goods are equalized in the two markets.
The reverse is the case in country B. When a country has an excess of natural gas, it can decide, aside from building a supply for local use, to export this to other countries. Moreover, did any such price equalization occur, it would contain the seed of its own destruction. The assumption of two productive factors, capital and labor, allows for the introduction of another realistic feature in production; that of differing factor proportions both across and within industries. The country with relatively more capital specializes - but not necessarily fully - in production of capital-intensive goods which it exports in exchange for labor-intensive goods while the country with relatively little capital specializes in production of labor-intensive goods which it exports in exchange for capital-intensive goods.
How to cite this article: Mulder, P. Let us now examine the commonsense explanation of factor price equalization. This result is called the Factor Price Equalization Theorem. Likewise, the demand for land would have to be concentrated on abundant land areas and the demand for capital on districts well supplied with capital. Other goods require less equipment to produce and rely mostly on the efforts of the workers. Here, capital refers to the physical machines and equipment that is used in production.
Let us begin with the H-O theorem. Prices may fall even further, relative to those of non-member countries, and the process of trade creation continues. What theories have emerged to explain such trade? Inter-industry trade is a trade of products that belong to different industries. In the long-run equilibrium under conditions of perfect competition, relative prices of commodities, as determined by demand and supply, are equal to average cost of production. The magnification effect allows for analysis of any change in the prices of the both goods and provides information about the magnitude of the effects on the wages and rents.