CH Institute of Management & CommerceIndore (M. P.) SUBJECT IB

PPT ON- MODERN TRADE THEORY (HECKSCHER-OHLIN THEORY)

Submitted to: Submitted by:PROF. MANMINDAR sir DIPTESH MISHRA PGPSM+MBA BATCH2 (B)

Bertil Ohlin

1899-1979 1977 Nobel PrizeELI FILIP HECKSCHER

Famous Swedish Economist

MODERN TRADE THEORYEXISTANCE:RICARDOS Comparative Advantage & Haberlers Theories was not success.REASONS:comparative advantage &comparative disadvantage in the production of one commodity to another.The ultimate determinants of comparative advantage The production possibilities vary from country to country.

MODERN TRADE THEORYKNOWN BY- HECKSCHER-OHLIN THEORY

why countries trade goods and services between two countries.

What determines comparative advantage?

What are the effects of international trade on the earnings of factors of production?

HECKSCHER-OHLIN THEORYAssumptions:

1. It is 2x2x2 model. There are 2- country (A&B), 2 commodities (Commodity X and Y), and 2 factors of production (Capital and Labor).

2. There is no changed in technological knowledge in production.

3. Different factor Intensive- Commodity X is labor intensive and commodity Y is capital intensive in both nationsCommodity X requires relatively more labor to produce than commodity Y.(K/L)X < (K/L)Y

HECKSCHER-OHLIN THEORYAssumptions:

4. Both commodities are produced under constant returns to scale in both countries.

5. There is incomplete specialization in production in both countries.

6. Tastes& preferences of consumer and the demand patterns in both countries are identical.

HECKSCHER-OHLIN THEORY

Assumptions:

7. There is perfect competition in both commodities and factor markets in both countries.Producers and consumers are too small to affect the price level.Normal profitHomogeneous products and inputs.Perfect knowledge.

8. There is perfect factor mobility within each nation but no international factor mobility.

HECKSCHER-OHLIN THEORY

Assumptions:

9. There are no transportation costs, tariffs or other obstructions to the free flow of international trade.

10. All resources are fully employed in both countries.

11. International trade between two countries is balanced.

HECKSCHER-OHLIN THEORY

12. There are quantitative difference in the factors and govt. in different reasons but qualitative there homogeneous.PHYSICAL CRITERIYA- Factor-Price Ratio- Pc1 Pc2 < PL1 PL2

HECKSCHER-OHLIN THEORYFactor Intensity:

Commodity Y is capital intensive if the (K/L) ratio used in the production Y is greater than (K/L) used in the production of X.

Commodity X is labor intensive if the (L/K) ratio used in the production X is smaller than (L/K) used in the production of Y.

Factor Intensity:

oO E R T LQFSKyXHG

HECKSCHER-OHLIN THEORYFactor Abundance:

Physical units: In terms of overall amount of capital and labor available to each nation.

Nation 2 is capital abundant if: (KA/LA)2 > (KB/LB)1Considers only supply

Relative factor prices: In terms of rental price of capital and the price of labor time in each nation.

Nation 2 is capital abundant if: (PK/PL)2 < (PK/PL)1Considers both supply and demand

HECKSCHER-OHLIN THEORYHeckscher-Ohlin Theorem:

A nation will export the commodity whose production requires the intensive use of the nations relatively abundant and cheap factor and import the commodity whose production requires the intensive use of the nations relatively scarce and expensive factor.

HECKSCHER-OHLIN THEORYAccording to this theory:

Nation2 exports commoditay Y because commodity Y is the K-intensive commodity and K is the relatively abundant and cheap factor in Nation 2.

Nation 1 exports commodity X because commodity X is the L-intensive commodity and L is the relatively abundant and cheap factor in Nation 1.

GENERAL EQUILIBRIUM WITH TRADE

oO D B R XQA H EPCYyXJ FG I - ---------------

CONCLUSION Y = HG = JE X= JF = HEH-O suggests that each nation will have a comparative advantage in the goods that intensively use its abundant factors. With free trade, each nation will specialize in and exports its comparative advantage goods.

Criticism Of The Heckscher - Ohlin Theory

Nations do not initiate trade: this is done by individuals or individual firms within nations.There must be perfect information and perfect competition between trading partners, which is never the case.They are limited because they do not look at either the transfer of goods or direct investments.They do not recognize the influence of technology and expertise in the areas of marketing and management.