Heckscher-Ohlin Model Assumptions - Fixed versus Variable Proportions

Two different assumptions can be applied in a Heckscher-Ohlin model: fixed and variable proportions. A fixed proportions assumption means that the capital-labor ratio in each production process is fixed. A variable proportions assumption means that the capital-labor ratio can adjust to changes in the wage rate for labor and rental rate for capital.

Fixed proportions is a more simplistic and also less realistic assumption. However, many of the primary results of the H-O model can be demonstrated within the context of fixed proportions. Thus the fixed proportions assumption is useful in deriving the fundamental theorems of the H-O model. The variable proportions assumption is more realistic but makes solving the model significantly more difficult analytically. To derive the theorems of the H-O model under variable proportions often requires the use of calculus.

Fixed Factor Proportions

Fixed factor proportions means that a_KC, a_LC, a_KS, and a_LS are exogenous to the model and are fixed. Since the capital-output and labor-output ratios are fixed, the capital-labor ratios, and , are also fixed. Thus, clothing production must use capital to labor in a particular proportion regardless of the quantity of clothing produced. The ratio of capital to labor used in steel production is also fixed but is assumed different from the proportion used in clothing production.

Variable Factor Proportions

Under variable proportions the capital-labor ratio used in the production process is endogenous. The ratio will vary with changes in the factor prices. Thus if there were a large increase in wage rates paid to labor, producers would reduce their demand for labor and substitute relatively cheaper capital in the production process. This means a_KC and a_LC are variable rather than fixed. So as the wage and rental rates change, the capital output ratio and the labor output ratio are also going to change.

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