International Trade

Hecksher-Ohlin Model - Trade

Comparative Advantage

H is L-abundant, and X is L-intensive H has Comparative Advantage in X.

F is K-abundant, and Y is K-intensive F has Comparative Advantage in Y.

Specialisation Hecksher-Ohlin Theory predicts that, when H and F start to trade, H will specialise in producing X and F will specialise in producing Y. More generally, a country specialises in producing goods for which the country has a Comparative Advantage (Remember factor intensity and factor endowment determine "CA"). This is because / < / before trade. After trade, H will produce more X because PX relatively increases in F, and F will produce more Y because PY relatively increases in H. As they trade, in H, / increases [1] and in F, / decreases. [2] They will not trade any more when / = / = / . As a result, H produces at E'H [3] and F produces at E'F [4] . H and F's utility increases to I'H and I'F respectively. [5]

Consumption and Utility Producing at E'H, H can consume at any point on the new world price ratio. [1] To maximise utility, H will consume at the point [2] where the tangent to the indifference curve coincides with that of the price ratio, i.e. at CH. By the same logic, F produces [3] at E'F and consumes [4] at CF.

	H	F
Production	EHE'H (X, Y)	EFE'F (X, y)
Consumption	EHCH	EFCF
Export	E'HAH of X	E'FAF of Y
Import	CHAH of Y	CFAF of X

To be in the trade equilibrium, X's export (E_H'A_H) = F's import (C_FA_F)
H's import (C_HA_H) = F's export (E'_FA_F)

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[Topic] Hecksher-Ohlin Model

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