Factor endowments and trade (the Heckscher-Ohlin model)
Output and input price effects
Situation:
2 resources: K=capital and L=labor
2 goods: B=labor-intensive basic goods and
C=capital-intensive complex goods and
2 countries: DC=a capital-abundant country and LDC=a
labor-abundant country |
 |
Example (the numbers are just to illustrate--the
idea is the important thing):
Production cost information (illustrating the greater
labor-intensity of B compared to C): |
|
Proportion of cost accounted for by |
|
Labor (L) |
Capital (K) |
| Good B |
0.8 |
0.2 |
| Good C |
0.2 |
0.8 |
|
| Pretrade factor price comparisons (illustrating
the greater capital-abundance of the DC compared to the LDC): |
| In the DC: |
PL is 80% higher (%DPL = +80%) and |
|
PK is 40% lower (%DPK=-40%). |
|
| Pretrade output price comparisons based on the
resource price differences: |
| In the DC: |
PB is 56% higher (%DPB=+56%)
[.8·(+80%) + .2·(-40%) = +56%], and |
|
PC is 16% lower (%DPC = -16%)
[.2·(+80%) + .8·(-40%) = -16%]. |
|
|
| So the pretrade situation looks like this: Notice that the higher-priced labor in the DC can afford more of both B and C
than in the LDC, and the lower-priced capital in the DC can't afford as much of either B
or C.
The results of free trade: With free trade,
output and input prices will converge across the DC and the LDC to somewhere between their
starting values. Exactly where depends on the sizes of the two economies. But notice that
the pattern of price convergence is the same, only the extent differs.
The key is that the PL and PK lines are the steepest--all of the
product price lines lie in between because every product's price depends partly on PL and
partly on PK. |
 |
With free trade:
(2) For the LDC, PL will rise compared to both PB and PC, so the real
income of labor will rise. PK will fall compared to both PB and PC, so the real income of
capital will fall.
(1) For the DC, PK will rise compared to both PB and PC, so the real
income of capital will rise. PL will fall compared to both PB and PC, so the real income
of labor will fall.
The theorem: Free trade raises the real income of a country's
abundant factor and lowers the real income of a country's scarce factor.