H-O model
INTRODUCTION
Uncountable number of trades takes place all over the world every minute no matter in developed countries or the developing ones. The theoretical foundation of international trade is from classic economic theory that dates from the nineteenth century - the Ricardian Model. The model shows that a country’s production and trade pattern is determined by comparative advantage, which is based on the differences in the productivity of labour. In reality, there are more factors that require to be taken account of, like labour, land, capital etc. Due to the differences in factor proportions, trade can be generated between countries of all kinds. To explain this we can use the Heckscher-Ohlin Model.
HECKSCHER-OHLIN MODEL
We will focus on the simplest version of H-O model, in which there are two countries (Home and Foreign), two goods (textile and wheat) and two factors of production (low-skilled labour and high-skilled labour). Home and Foreign are identical in tastes, technology and the quality of factors of production1. Each good will be produced with both factors of production under constant return to scale and these two factors are completely mobile between industries but completely immobile internationally. There are no transportation costs for the goods and perfect competition in each sector and in international level.
The crucial points of this model are the following two:
Firstly, the two countries have different factor proportions. By assumptions, Home is relatively high-skilled labour (HSL) abundant since HSL/LSL is greater than (HSL/LSL)*2 and correspondingly, Foreign is relatively low-skilled labour (LSL) abundant since LSL/HSL is greater than (LSL/HSL)*. Notice that a country cannot be both high-skilled labour- and low-skilled labour- abundant, because abundance is defined in terms of ratio and not in absolute quantities. As shown above, we could tell which country is abundant by comparing the ratio of the two factors of production.
Uncountable number of trades takes place all over the world every minute no matter in developed countries or the developing ones. The theoretical foundation of international trade is from classic economic theory that dates from the nineteenth century - the Ricardian Model. The model shows that a country’s production and trade pattern is determined by comparative advantage, which is based on the differences in the productivity of labour. In reality, there are more factors that require to be taken account of, like labour, land, capital etc. Due to the differences in factor proportions, trade can be generated between countries of all kinds. To explain this we can use the Heckscher-Ohlin Model.
HECKSCHER-OHLIN MODEL
We will focus on the simplest version of H-O model, in which there are two countries (Home and Foreign), two goods (textile and wheat) and two factors of production (low-skilled labour and high-skilled labour). Home and Foreign are identical in tastes, technology and the quality of factors of production1. Each good will be produced with both factors of production under constant return to scale and these two factors are completely mobile between industries but completely immobile internationally. There are no transportation costs for the goods and perfect competition in each sector and in international level.
The crucial points of this model are the following two:
Firstly, the two countries have different factor proportions. By assumptions, Home is relatively high-skilled labour (HSL) abundant since HSL/LSL is greater than (HSL/LSL)*2 and correspondingly, Foreign is relatively low-skilled labour (LSL) abundant since LSL/HSL is greater than (LSL/HSL)*. Notice that a country cannot be both high-skilled labour- and low-skilled labour- abundant, because abundance is defined in terms of ratio and not in absolute quantities. As shown above, we could tell which country is abundant by comparing the ratio of the two factors of production.
References: AND DIAGRAMS Findlay R. (2008). Comparative Advantage The New Palgrave Dictionary of Economics, Second Edition Freeman R. (1995). Are Your Wages Set in Beijing? Journal of Economic Perspectives- Volume 9, Number 3-Summer 1995-Pages 15-32 Krugman P. and Obstfeld M. (2006). International Economics Theory & Policy (7th edition) Pearson International Edition Smit, A. J. (2010) The Competitive Advantage of Nations: Is Porter’s Diamond Framework a New Theory that Explains the International Competitiveness of Countries? Southern African Business Review Volume 14 Number 1