1. International Economics
Li Yumei
Economics & Management School
of Southwest University

2. International Economics
Chapter 5
Factor Endowments and the Heckscher-Ohlin Theory

3. Organization 5.1 Introduction 5.2 Assumptions of the Theory
5.3 Factor Intensity, Factor Abundance, and the Shape of the Production Frontier
5.4 Factor Endowments and the Heckscher-Ohlin Theory
5.5 Factor-Price Equalization and Income Distribution
5.6 Empirical Tests of the Heckscher-Ohlin Model
Chapter Summary
Exercises

4. Hechscher-Ohlin Trade Model
5.1 Introduction
Hechscher-Ohlin Trade Model
To extend the trade model to identify one of the most important determinants of the difference in the pretrade-relative commodity prices and the comparative advantage among nations;
To examine the effect that the international trade has on the relative price and income of the various factors of production
Other more recent trade models
Leontief Paradox

5. 5.1 Introduction Answer Two Questions
The basis of comparative advantage: further explanation of the reason or cause for the difference in relative commodity prices and comparative advantage between the two nations;
The effect of international trade on the earnings of factors of production in the two trading nations: to examine the effect of international trade on the earnings of labor as well as on international differences in earnings

6. 5.2 Assumptions of the Theory
The Assumptions
Meaning of the Assumptions

7. The Assumptions
1. Two nations, two commodities (X and Y) and two factors (labor and capital);
2. Both nations use the same technology in production;
3. Commodity X is labor intensive, and commodity Y is capital intensive in both nations;
4. Both commodities are produced under constant returns to scale in both nations;
5. There is incomplete specialization in production in both nations;
6. Tastes are equal in both nations;

8. The Assumptions
7. There is perfect competition in both commodities and factor markets in both nations;
8. There is perfect factor mobility within each nation but no international factor mobility;
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 nations;
11. International trade between the two nations is balanced;

9. Meaning of the Assumptions
More realistic case of assumption 1;
Assumption 2 of same technology means that both nations have access to and use the same general production techniques.
If factor prices were same, the two nations would use the exactly
same amount of labor and capital in the production of each
commodity; since factor prices usually differ, producers in each
nation will use more of the relatively cheaper factor in the nation to
minimize their costs of production.

10. Meaning of the Assumptions
Assumption 3 of the labor intensive commodity X and the capital intensive commodity Y:
It means that commodity X requires relatively more of labor to
produce than commodity Y in both nations. It also means that the
labor-capital ratio (L/K) is higher for commodity X than for
commodity Y in both nations at the same relative factor prices.
This is equivalent to saying that the K/L ratio (capital-labor ratio) is
lower for X than for Y in both nations, but not mean K/L ratio for X
is the same in both nations.

11. Meaning of the Assumptions
Assumption 4 of constant returns to scale
It means that increasing the amount of labor and capital used in
Production of any commodity will increase output of that commodity
in the same proportion.
Assumption 5 of incomplete specialization
It means that even with free trade both nations continue to produce
both commodities. This implies that neither of the two nations is “very
small”.
Assumption 6 of equal tastes
It means that demand preferences, as reflected in the shape and
location of indifference curves are identical in both nations.

12. Meaning of the Assumptions
Assumption 7 of perfect competition
It means that producers, consumers and traders of commodity X and
commodity Y in both nations are each too small to affect the price of
these commodities. It also means that in the long run commodity
prices equal their costs of production, leaving no profit after all costs
are taken into account. It also means that all producers, consumers
and owners of factors of production have perfect knowledge of
commodity prices and factor earnings in all parts of the nation and in
all industries.

13. Meaning of the Assumptions
Assumption 8 of perfect internal factor mobility
It means that labor and capital are free to move, and indeed do
move quickly from areas and industries of lower earnings to areas
and industries of higher earnings until earnings for the same type of
labor and capital are the same in all areas, uses, and industries of
the nation. On the other hand, there is zero international factor
mobility.
Assumption 9 of no transportation costs or other trade obstructions
It means that specialization in production proceeds until relative
commodity prices are the same in both nations with trade.

14. Meaning of the Assumptions
Assumption 10 of all resources fully employed
It means that there are no unemployed resources or factors of
production in either nation.
Assumption 11 of the balanced trade
It means that the total volume of each nation’s exports equals the
total volume of the nation’s imports.

15. 5.3 Factor Intensity, Factor Abundance, and the Shape of the Production Frontier

16. Figure 5.1 Factor Intensity
FIGURE 5-1 Factor Intensities for Commodities X and Y in Nations 1 and 2

17. Explanation of Figure 5.1 Factor Intensity
1. The horizontal axis refers to the amount of labor while the
vertical axis refers to the amount of capital, and the slope of
the ray measures the capital-labor ratio (K/L) in the
production of the commodity;
2. Nation 1’s slope of the rays (K/L) in the production of
Commodity X and Commodity Y;
1) K/L in Y=1 ( 2 K and 2 L for 1 Y, 4K and 4L for 2Y with constant returns to scale);
2) K/L in X=1/4 (1K and 4L for 1X, 2K and 8L for 2X with constant returns to scale;
3. Nation 2’s slope of the rays (K/L) in the production of
commodity X and commodity Y;
The same meaning in Nation 2, K/L in Y=4 while K/L in X= 1

18. Factor Intensity Conclusion
1. Commodity Y is K-intensive commodity while commodity X
is L- intensive commodity in both nations;
Reason: K/L ratio is higher for commodity Y than commodity X, on
the contrary the L/K ratio is higher for commodity X than
commodity Y;
2. K/L ratio in Nation 2 is higher than Nation 1 in both
commodities X and Y;
Reason: the capital must be relatively cheaper in Nation 2 than in Nation 1, so that producers in Nation 2 use relatively more capital in the production of both commodities to minimize their costs of production. ( factor abundance and its relationship to factor prices later explanation) . In other words, the relative capital price (r/w) is lower in Nation 2 than in Nation1. If r/w declined, producers would substitute K for L in the production of both commodities to minimize their costs of production. As a result, K/L would rise for both commodities, but Commodity Y continues to be K-intensive commodity (assumption).

19. Definition of Factor Abundance
1. The terms of physical units
It means the overall amount of capital and labor available to
each nation.
2. The terms of relative factor prices
It means the rental price of capital and the price of labor time in
Factor Abundance
1. Nation 2 is capital abundant if the ratio of the total amount
of capital to the total amount of labor (TK/TL) available in
Nation 2 is greater than that in Nation 1. (according to
physical units of factor abundance)

20. Factor Abundance
2. According to the definition in terms of factor prices, Nation
2 is capital abundant if the ratio of the rental price of capital
to the price of labor time (PK/PL) is lower in Nation 2 than in
Nation 1. Since the rental price of capital is usually taken to
be the interest rate ( r ) while the price of labor time is the
wage rate ( w ), PK/PL= r/w
3. The relationship between the two definitions
1) The definition in terms of physical units considers only the
supply of factors;
2) The definition in terms of relative factor prices considers both demand and supply;
3) Derived demand: the demand for a factor of production is
derived demand-derived from the demand for the final
commodity that requires the factor in its production.

21. Factor Abundance Conclusion
1. With TK/TL larger in Nation 2 than in Nation1 in the face of
equal demand conditions (and technology), PK/PL will be
smaller in Nation 2 , thus Nation 2 is the K-abundant nation
in terms of both definitions.
2. This is not always the case.
Reason: the demand for Y and the demand for capital, could be so
much higher in Nation 2 than in Nation 1 that the relative price of
capital would be higher in Nation 2 than in Nation 1(alrough the
relative greater supply of capital in Nation 2). In this case, Nation 2
would be considered K abundant according to the definition in
physical terms and L abundant according to the definition in terms
of relative factor prices.

22. Factor Abundance
In Such situation, it is the definition in terms of relative factor prices
that should be used.
3. Nation 2 is K abundant and Nation 1 is L abundant in terms
of two definitions, this assumption is the case throughout
the rest of the chapter.

23. Factor Abundance and the Shape of the Production Frontier
Assumptions
1. Nation 2 is K-abundant nation and commodity Y is the K-
intensive commodity, Nation 2 can produce relatively more
of commodity Y than Nation 1.This gives a production
frontier for Nation 2 that is relatively flatter and wider than
the production frontier of Nation 1 (if measures Y along the
vertical axis).
2. Nation 1 is L-abundant nation and commodity X is the L-
intensive commodities, Nation 1 can produce relatively
more of commodity X than Nation 2. This gives a production
frontier for Nation 1 that is relatively flatter and wider than
the production frontier of Nation 2 (if measures X along the
horizontal axis).

24. Factor Abundance and the Shape of the Production Frontier
Figure 5.2
FIGURE 5-2 The Shape of the Production Frontiers of Nation 1 and Nation 2

25. Factor Abundance and the Shape of the Production Frontier
Explanation of Figure 5.2
1. Nation 1’s production frontier is skewed toward the
horizontal axis, which measures commodity X.
Reason: Nation 1is a L-abundant nation and commodity X is L-
intensive .
2. Nation 2’s production frontier is skewed toward the vertical
axis, which measures commodity Y.
Reason: Nation 2 is a K-abundant nation and commodity Y is K-
Case Studies
1. Case study 5-1: the relative resources endowments of various countries and regions. (page 123)
2. Case study 5-2: the capital stock per worker for a number of leading developed and developing countries. (page 124)

26. 5.4 Factor Endowments and the Heckscher-Ohlin Theory
The Heckscher-Ohlin Theorem
General Equilibrium Framework of the Heckscher-Ohlin Theory
Illustration of the Hechscher-Ohlin Theory

27. Brief Introduction Eli Heckscher (1879 - 1952)
He (Stockholm November 24, Stockholm
December 23, 1952) was a Swedish political
economist and economic historian. Heckscher was
born in Stockholm into a prominent Jewish family,
son of the Danish-born businessman Isidor
Heckscher and his spouse Rosa Meyer, and
completed his secondary education there in 1897.
He studied at university in Uppsala and Gothenburg,
completing his PhD in Uppsala in He was
professor of Political economy and Statistics at the
Stockholm School of Economics from 1909 until 1929, when he

28. Eli Heckscher ( )
exchanged that chair for a research professorship in economic history, finally retiring as emeritus professor in According to a bibliography published in 1950, Heckscher had as of the previous year published 1148 books and articles, among which may be mentioned his study of Mercantilism, translated into several languages, and a monumental Economic history of Sweden in several volumes. Heckscher is best known for a model explaining patterns in international trade (Heckscher-Ohlin model) that he developed with Bertil Ohlin at the Stockholm School of Economics

29. Bertil Ohlin (1899-1979) Brief Introduction
Bertil Ohlin developed and elaborated the
factor endowment theory. He was not only
a professor of economics at Stockholm, but
also a major political figure in Sweden. He
served in Riksdag (Swedish Parliament),
was the head of liberal party for almost a
1/4 of a century. He was Minister of Trade
during World War II. In 1979 Ohlin was awarded a Nobel prize jointly with James Meade for his work in international trade theory.

30. Bertil Ohlin ( )
Bertil Gotthard Ohlin (pronounced [ˈbærtil uˈliːn]) (23 April 1899 – 3 August 1979) was a Swedish economist and politician. He was a professor of economics at the Stockholm School of Economics from 1929 to He was also chairman of the Swedish People's Party, a social-liberal party which at the time was the largest party in opposition to the governing Social Democratic Party, from 1944 to He served briefly as from 1944 to 1945 in the Swedish .
Ohlin's name lives on in one of the standard mathematical model of international free trade, the Heckscher-Ohlin model, which he developed together with Eli Heckscher. He was jointly awarded the Nobel Memorial Prize in Economics in 1977 together with the British economist James Meade "for their pathbreaking contribution to the theory of international trade and international capital movements".

31. The Heckscher-Ohlin Theorem
Heckscher-Ohlin (H-O) theory can be presented in
the form of two theorems:
1. The so-called H-O theorem (which deals with and predicts the pattern of trade)
2. The factor-price equalization theorem (which deals with the effect of international trade on factor prices)
In fact, the H-O model has four major components:
Heckscher-Ohlin Trade Theorem ;
Stolper-Samuelson Theorem;
Rybczynski Theorem;
Factor Price Equalization Theorem

32. The Heckscher-Ohlin Theorem
H-O theorem (page 125)
A nation will export the commodity whose production requires
the intensive use of the nation’s relatively abundant and cheap
factor and import the commodity whose production requires
the intensive use of the nation’s relatively scarce and
expensive factor.
Explanation of H-O theorem (factor endowment)
1. The basis for trade: Relative factor abundance or factor
endowments as the basis for international trade or the basic
cause or determinant of comparative advantage.

33. The Heckscher-Ohlin Theorem
2. Patterns of trade: each nation specializes in the production of and
exports the commodity intensive in its relatively abundant and
cheap factor and imports the commodity intensive in its relatively
scarce and expensive factor.
Conclusion
H-O theorem explains comparative advantage rather than assuming
it . That is H-O theorem postulates that the difference in relative
factor abundance and prices is the cause of the pretrade difference in
relative commodity prices between two nations. This difference in
relative factor and relative commodity prices is then translated into a
difference in absolute factor and commodity prices between the two
nations. It is this difference in absolute commodity prices in the two
nations that is the immediate cause of trade.

34. The Heckscher-Ohlin Theorem
Conclusion
The H-O theorem predicts the pattern of trade between countries
based on the characteristics of the countries. The H-O theorem
says that a capital-abundant country will export the capital-intensive
good while the labor-abundant country will export the labor-intensive
good.
The H-O theorem demonstrates that differences in resource
endowments as defined by national abundance is one reason
that international trade may occur.
Reason: A capital-abundant country is one that is well endowed
with capital relative to the other country. This gives the country
a propensity for producing the good which uses relatively more
capital in the production process .

35. General Equilibrium Framework of the Heckscher-Ohlin Theory
Figure 5.3
1. The tastes and the distribution in the ownership of factors of
production together determine the demand for commodities.
2. The demand for commodities determines the derived demand for
the factors required to produce them.
3. The demand for factors of production, together with the supply of
the factors, determines the price of factors of production under
perfect competition.
4. The price of factors of production, together with technology,
determines the price of final commodities.
5. The difference in relative commodity prices between nations determines comparative advantage and the pattern of trade

36. FIGURE 5-3 General Equilibrium Framework of the Heckscher-Ohlin Theory

37. General Equilibrium Framework of the Heckscher-Ohlin Theory
Conclusion
1. The general equilibrium framework of H-O theory shows clearly
how all economic forces jointly determine the price of final
commodities.
2. Out of all economic forces working together, H-O isolates the
difference in the physical availability or supply of factors of
production among nations ( in the face of equal tastes and
technology) to explain the difference in relative commodity prices
and trade among nations. And different supply of factors of
production in different nations have different factor prices.
3. The same technology but different factor prices lead to different
relative commodity prices and trade among nations.

38. Illustration of the Hechscher-Ohlin Theory
Figure 5.4
FIGURE 5-4 The Heckscher-Ohlin Model

39. Illustration of the Hechscher-Ohlin Theory
Explanation of Figure 5.4
1. Left panel: it shows the production frontier of Nation 1 and 2
1) Nation 1’s production frontier is skewed along the X-axis;
2) Nation 2’s production frontier is skewed along the Y-axis;
3) Indifference curve Ⅰis tangent to Nation 1’s production frontier
at point A while point A’ in Nation 2’s (due to the equal tastes);
4) A represents Nation 1’s equilibrium points of production and
consumption while A’ represents Nation 2’s equilibrium points of
production and consumption in the absence of trade;
5) Since the equilibrium-relative commodity prices of PA﹤PA’,
Nation has a comparative advantage in commodity X while
Nation 2 in Commodity Y.

40. Illustration of the Hechscher-Ohlin Theory
2. Right panel: With trade the equilibrium point
1) Nation 1 specializes in the production of commodity X while Nation 2
in commodity Y;
2) Specialization in production proceeds until the transformation curves
of the two nations are tangent to the common relative price line PB.
3) After trade, Nation 1 will export commodity X in exchange for
commodity Y and consume at point E on indifference curveⅡ.
Nation 2 will export commodity Y in exchange for commodity X
and consume at point E’ on indifference curveⅡ.
4) PX/PY=PB, equilibrium point; if PX/PY﹥PB, Nation 1 wants to
export more of commodity X than Nation 2 wants to import at this
high relative price of X, and PX/PY falls toward PB; on the
contrary, if PX/PY﹤PB, Nation 1 wants to export less of commodity X
than Nation 2 wants to import , and PX/PY rises toward PB.

41. Illustration of the Hechscher-Ohlin Theory
Conclusion
Both nations gain from trade because they consume on higher
indifference curve Ⅱ.
Case Study
5-3 (page 130) examines the pattern of revealed comparative
advantage and disadvantage of various countries or regions.

42. 5.5 Factor-Price Equalization and Income Distribution
The Factor-Price Equalization Theorem
Relative and Absolute Factor-Price Equalization
Effect of Trade on the Distribution of Income
The Specific-Factors Model
Empirical Relevance

43. The Factor-Price Equalization Theorem
The Content of Factor-Price Equalization Theorem
The factor-price equalization theorem says that when the
prices of the output goods are equalized between countries,
as when countries move to free trade, then the prices of the
factors (capital and labor) will also be equalized between
countries. This implies that free trade will equalize the wages
of workers and the rents earned on capital throughout the
world.
The factor-price equalization theorem was rigorously proved
by Paul Samuelson (1970 Nobel prize in economics) , so it was
also called H-O-S theorem. ( page 129)

44. The Factor-Price Equalization Theorem
Explanation of H-O-S Theorem
1. In Nation 1 the relative price of commodity X is lower than in
Nation 2, it means that the relative price of labor or wage
rate is lower in Nation1 in the absence of trade;
2. With trade, Nation 1 specializes in the production of
commodity X (L-intensive commodity) and reduces its
production of commodity Y(K-intensive commodity), the
demand for labor rises causes the wages to rise while the
relative demand for capital falls and its rate falls; on the
other hand, in Nation 2 wages fall and rate rises;

45. The Factor-Price Equalization Theorem
Conclusion
1. International trade tends to reduce the pretrade difference in
w and r between the two nations;
2. International trade keeps expanding until relative
commodity prices are completely equalized, which means
that relative factor prices have also become equal in two
nations.

46. Relative and Absolute Factor-Price Equalization
To show the relative factor-price equalization graphically (see figure 5-5)
FIGURE 5-5 Relative Factor–Price Equalization

47. Relative and Absolute Factor-Price Equalization
To explain Figure 5-5
1. The horizontal axis measures the relative price of labor (w/r)
while the vertical axis measures the relative price of
commodity X (PX/PY);
2. Each w/r is associated with a specific PX/PY ratio (due to the
perfect competition and uses the same technology, one to
one relationship between w/r and PX/PY);
3. Without trade, Nation 1 is at Point A with w/r=(w/r)1 and
PX/PY=PA while Nation 2 is at Point A’ with w/r=(w/r)2 and
PX/PY=PA’;
4. With trade, Nation 1 will produce more of commodity X due to
the PA ﹤PA’ in the relative price of commodity X in Nation 1 than
Nation 2 while Nation 2 will produce more of commodity Y .

48. Relative and Absolute Factor-Price Equalization
5. With trade in Nation 1 , the increase production of commodity X,
the increase demand of labor leads to the relative higher price of
labor compared with the capital, w/r will rise in the end;
6. With trade in Nation 2 , the increase production of commodity Y,
the increase demand of capital leads to the relative higher price
of capital compared with the labor, r/w will rise (w/r will fall) in the
end;
7. The upward movement in Nation 1 and downward movement in
Nation 2 will continue until point B=B’, at which PB=PB’ and
w/r=(w/r) ﹡(only at this point both nations operate under
perfection competition and use the same technology by
assumption)

49. Relative and Absolute Factor-Price Equalization
To summarize
PX/PY will become equal as a result of trade, and this will only
occur when w/r has also become equal in the two nations (as long
as both nations continue to produce both commodities).
Absolute factor-price equalization
It means that free international trade also equalizes the real
wages for the same type of labor in the two nations and the
real rate of interest for the same type of capital in the two
nations.

50. Relative and Absolute Factor-Price Equalization
Assumptions of the relative and absolute factor-price equalization
Perfect competition in all commodities and factor markets;
The same technology;
The constant returns to scale;
Conclusion
Trade equalizes the relative and absolute returns to homogeneous factors;
Trade acts as a substitute for the international mobility of factors of production in its effect on factor prices;
Trade operates on the demand for factors, factor mobility operates on the supply of factors.

51. Effect of Trade on the Distribution of Income
International trade on the effect of relative factor prices within each nation
Trade increases the price of the nation’s abundant and cheap factor and reduces the price of its scarce and expensive factor.
E.G. W rises and r falls in Nation 1 while w falls and r rises in Nation 2.
International trade on the effect of income within each nation
The real income of labor and the real income of owners of capital move in the same direction as the movement in factor prices
E.G. Trade causes the real income of labor to rise and the real income of owners of capital to fall in Nation 1 while in Nation 2 the situation is the opposition. (Stolper-Samuelson Theorem)

52. Effect of Trade on the Distribution of Income
Stolper-Samuelson Theorem:
(Details in 8.4c page 251)
The theorem postulates that an increase in the relative price of
a commodity raises the return or earnings of the factor used
intensively in the production of the commodity.
Application
Developed countries
Developed countries are the relatively capital abundant factor,
international trade tends to reduce the real income of labor and
increase the real income of owners of capital. This is why labor
union generally favor trade restrictions.( Case study 5-4 page 135)
Developing countries

53. Effect of Trade on the Distribution of Income
Conclusion
International trade on the effect of relative factor prices and the distribution of income within each nation in the long run;
According to H-O-S theorem and Stolper- Samuelson theorem, international trade causes real wages and the real income of labor to fall in a capital-abundant and labor –scarce nation (such as developed countries). On the contrary, international trade causes real interests and the real income of capital to fall in a labor-abundant and capital scarce nation (such as developing countries);
Unequal distribution of income needs an appropriate distribution policy of the government. (detail in Chapter 8)

54. The Specific-Factors Model
Specific –Factor Model (Appendix Figure 5-9 page 155)
FIGURE 5-9 Specific-Factors Model

55. The Specific-Factors Model
Explanation- Ambiguous effect on mobile factor
1. Nation 1 is L-abundant nation and the labor is mobile between
industries but capital is not;
2. The wage of labor will be the same in the production of commodities
of X and Y in Nation 1 and given by the intersection of the value of
the marginal product of labor curve in the production of X and Y;
(VMPLY and VMPLX);
3. The horizontal axis measures the total supply of labor available to
Nation 1 while the vertical axis measures the wage rate;
4. No-trade, the equilibrium point is at E with wage rate ED, OD of labor in X and DO’ of labor in Y;
5. With trade, PX/PY rises, VMPLX moves upward to VMPLX’, the
result is that the wage rate increase (from ED to E’D’) less than
the price increase (EF) proportionately, and DD’ is the increased
labor of X, w falls in X and rises in Y (due to the unchanged price of
commodity Y).

56. The Specific-Factors Model
Explanation- Unambiguous effect on immobile factor
1. Nation 1 is L-abundant nation and the labor is mobile between
industries but capital is immobile;
2. More labor work for the production of X with given amount of capital,
it means that VMPKX and r increase in terms of both commodities,
while less labor is used with the fixed capital in the production of Y,
VMPKY and r fall in terms of Y;
3. With trade, the real income of the immobile capital (the nation’s
scarce factor) rises in the production of X and falls in the production
of Y while real wages fall in terms of X and rise in terms of Y.

57. The Specific-Factors Model
Conclusion
In the short run when some factors my be immobile or
specific to some industry or sector. In this case, it postulates
that trade will have an ambiguous effect on the nation’s
mobile factors : It will benefit the immobile factors that are
specific to the nation’s export commodities or sectors, and
harm the immobile factors that are specific to the nation’s
import-competing commodities or sectors.

58. The Specific-Factors Model
Conclusion
In the long run when all input are mobile among all industries
of a nation, the H-O model postulates that the opening of
trade will lead to an increase in the real income or return of
the inputs used intensively in the nation’s export sectors and
to a reduction in the real income or return of the inputs used
intensively in the production of the nation’s import-competing
sectors.

59. Empirical Relevance Unreal Assumptions
In reality, the equalization of the returns to homogeneous
factors is not the case said as H-O-S model in different nations
with trade. The reasons as follows: Such as same technology, no
transportation cost, free trade, perfect competition and constant
returns to scale.
Adjustment of H-O-S Model: International trade can reduce the
international difference in the returns to homogeneous factors.
Reason: even if international trade has operated to reduce the
absolute difference in factor returns among nations, many other
forces were operating at the same time, preventing any such
relationship from becoming clearly evident (e.g. trade restrictions).

60. Factor-price equalization theorem
Empirical Relevance
Factor-price equalization theorem
Usefulness
The reason is that it identifies crucial forces affecting factor prices
and provides important insights into the general equilibrium nature
of out trade model and of economics in general.
Shortcoming
It doesn’t say that international trade will eliminate or reduce
international differences in per capita incomes. It only predicts
international trade will eliminate or reduce international differences
in the returns to homogeneous factors.
Reason: Per capita incomes depend on other many forces ( the
ratio of skilled to unskilled labor and so on). Even if real wages
were to be equalized among nations, their per capita incomes
could be still wider.

61. 5.6 Empirical Tests of the Heckscher-Ohlin Model
Empirical Results-The Leontief Paradox
Explanations of the Leontief Paradox
Factor-Intensity Reversal

62. Empirical Results-The Leontief Paradox
Wassily Leontief (1906–99)
American economist, b. Russia, grad. Univ. of Berlin
(Ph.D., 1928). The son of a Russian economist, he and
his family left the Soviet Union in 1925 because of their
opposition to the Bolshevik government. After serving
as an adviser on railroad construction to the Chinese
government (1929), he emigrated to the United States.
He joined the faculty of Harvard in 1931, rising to the
rank of professor in In 1975, he left Harvard to teach at New York
Univ. Leontief is best known for his development of the input-output
method of economic analysis, used by most industrialized nations for
planning and predicting economic progress. He was awarded (1973) the
Nobel Memorial Prize in Economic Sciences.

63. Wassily Leontief Paradox
Leontief's paradox in economics is that the country with the world's highest capital-per worker has a lower capital-labour ratio in exports than in imports.
This econometric find was the result of Professor Wassily W. Leontief's attempt to test the Heckscher-Ohlin theory empirically. In 1954, Leontief found that the U.S. (the most capital-abundant country in the world by any criteria) exported labor-intensive commodities and imported capital-intensive commodities, in contradiction with Heckscher-Ohlin theory ("H-O theory").

64. Measurements
In 1971 Robert Baldwin showed that US imports were 27% more capital-intensive than US exports in the 1962 trade data [1]using a measure similar to Leontief's.
In 1980 Leamer questioned Leontief's original methodology or Real exchange rate grounds, but acknowledged that the US paradox still appears in the data (for years other than 1947). [2]
A 1999 survey of the econometric literature by Elhanan Helpman concluded that the paradox persists, but some studies in non-US trade were instead consistent with the H-O theory.
In 2005 Kwok & Yu used an updated methodology to argue for a lower or zero paradox in US trade statistics, though the paradox is still derived in other developed nations. [3]

65. Responses to the Paradox
For many economists, Leontief's paradox undermined the validity of the H-O theory, which predicted that trade patterns would be based on countries' comparative advantage in certain factors of production (such as capital and labor). Many economists have dismissed the H-O theory in favor of a more Ricardian model where technological differences determine comparative advantage. These economists argue that the U.S. has an advantage in highly skilled labor more so than capital. This can be seen as viewing "capital" more broadly, to include human capital. Using this definition, the exports of the U.S. are very (human) capital-intensive, and not particularly intensive in (unskilled) labor.

66. Responses to the Paradox
Some explanations for the paradox dismiss the importance of comparative advantage as a determinant of trade. For instance, the Linder hypothesis states that demand plays a more important role than comparative advantage as a determinant of trade--with the hypothesis that countries which share similar demands will be more likely to trade. For instance, both the U.S. and Germany are developed countries with a significant demand for cars, so both have large automotive industries. Rather than one country dominating the industry with a comparative advantage, both countries trade different brands of cars between them. Similarly, New Trade Theory argues that comparative advantages can develop separately from factor endowment variation (e.g. in industrial increasing returns to scale).

67. Explanations of the Leontief Paradox
The used data was not representative;
Two-factor model (L, K) , ignoring the natural resources;
(Many production process using natural resources)
U.S. Trade policy (heavy protection of domestic labor-intensive industries, so more labor –intensive goods export);
Only the measure of physical capital and ignoring the human capital and “knowledge” capital;
At the same time there are many strong and convincing
evidences verifying H-O theory. (See Figure 5-6)
Case Study 5-7 (page 143)

68. FIGURE 5-6 Comparative Advantage with Skills and Land

69. Factor-Intensity Reversal
Concept
It means refers to the situation where a commodity is L intensive
in the L-abundant nation and K intensive in the K-abundant
nation.
This may occur when the elasticity of substitution of factors in production varies greatly for the two commodities.
With factor-intensity reversal, both H-O theorem and the factor-
price equalization theorem fail.
Controversial topic
Some tests show that factor reversal was fairly prevalent, some tests
provide strong confirmation of the H-O model.

70. Further the explanation of the comparative advantage;
Chapter Summary
Further the explanation of the comparative advantage;
(factor abundance → factor prices →the cost of production →the comparative advantage)
The explanation of international trade on the effect of factor prices and the returns of factors in different countries;
1. Effect on factor prices: the abundant factor’s price will rise while the scarce factor’s price will fall (factor- price equalization);

71. Chapter Summary 2. Effect on returns of factors:
(1) In the long run: the abundant factor’s return will rise while the scarce factor’s returns will fall (exported industries’ income will rise while import competing industries will fall );
(2) in the short run: the specific-factor model postulates that trade will have an ambiguous effect on the nation’s mobile factors; It will benefit the immobile factors that are specific to the nation’s export commodities or sectors, and harm the immobile factors that are specific to the nation’s import-competing commodities or sectors;

72. Chapter Summary
H-O Theory as the centerpiece of modern trade theory for explaining not only trade between developed countries and developing countries but also trade among developed countries and among developing countries;
Although the theory is controversial in empirical
studies, but most of studies provide strong and
convincing evidence .

73. Exercises
Discussion Questions:
Page 148 from 1 to 15 questions

74. Exercises Additional Reading
The original sources for the Hechscher-Ohlin theory are:
E.F.Hechscher, “ The Effect of Foreign Trade on the Distribution of Income,” Ekonomisk Tideskrift, 1919, pp
B. Ohlin, Interregional and International Trade (Cambridge, Mass.: Harvard University Press, 1983)
The original proof of the factor-price equalization theorem is
found in:
P.A. Samuelson, “International Trade and the Equalization of Factor Prices,” Economic Journal, June 1948, pp
P.A. Samuelson, “International Factor-Price Equalization Once again.”, Economic Journal, June 1949, pp

75. Exercises Additional Reading
For the effect of international trade on the distribution of
Income, see:
W.F. Stolper and P.A.Samuelson, “ Protection and Real Wages,” Review of Economic Studies, November 1941, pp
For excellent surveys of the Heckscher-Ohlin theory, see:
J.N.Bhagwati, “ The Pure Theory of International Trade: A Survey,” Economic Journal, pp. 1-84
J.S. Chipman, “A Survey of the Theory of International Trade,” Econometrica, 1965

76. Internet Materials http://www.imf.org