International Trade Theory and Policy
by Steven M. Suranovic

Trade 60-1A

Heckscher-Ohlin Model Assumptions - Market Structure

Perfect Competition prevails in all markets.

Two countries

The case of two countries is used to simplify the model analysis. Let one country be the US, the other France*. Note: anything related exclusively to France* in the model will be marked with an asterisk.

Two goods

Two goods are produced by both countries. We assume a barter economy. This means that there is no money used to make transactions. Instead, for trade to occur, goods must be traded for other goods. Thus we need at least two goods in the model. Let the two produced goods be clothing and steel.

Two factors

Two factors of production, labor and capital, are used to produce clothing and steel. Both labor and capital are homogeneous. Thus there is only one type of labor and one type of capital. The laborers and capital equipment in different industries are exactly the same. We also assume that labor and capital are freely mobile across industries within the country but immobile across countries. Free mobility makes the H-O model a long-run model.

Factor Constraints

The total amount of labor and capital used in production is limited to the endowment of the country.

The Labor Constraint is,

where and are the quantities of labor used in clothing and steel production, respectively. L represents the labor endowment of the country. Full employment of labor implies the expression would hold with equality.

The Capital Constraint is,

where and are the quantities of capital used in clothing and steel production, respectively. K represents the capital endowment of the country. Full employment of capital implies the expression would hold with equality.

Endowments

The only difference between countries assumed in the model is differences in endowments of capital and labor.

Definition

A country is capital-abundant relative to another country if it has more capital endowment per labor endowment than the other country. Thus in this model the US is capital-abundant relative to France if:

where K is the capital endowment, L the labor endowment in the US. K* is the capital endowment, L* the labor endowment in France.

Note that if the US is capital-abundant then France is labor-abundant since the above inequality can be rewritten to get:

This means that France has more labor per unit of capital for use in production than the US.

Demand

Factor owners are the consumers of the goods. The factor owners have a well-defined utility function in terms of the two goods. Consumers maximize utility to allocate income between the two goods.

When necessary we will assume that aggregate preferences can be represented by a homothetic utility function of the form where CS is the amount of steel consumed and CC is the amount of clothing consumed.

General Equilibrium

The H-O model is a general equilibrium model. The income earned by the factors is used to purchase the two goods. The industries' revenue in turn is used to pay for the factor services. The prices of outputs and factors in an equilibrium are those which equalize supply and demand in all markets simultaneously.

International Trade Theory and Policy - Chapter 60-1A: Last Updated on 7/31/06

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