2x2x2 model
- 2. Eli Heckscher (1879- 1952) (1899–1979)
- 3. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: ORIGIN • The theory was developed by the Swedish economist Bertin Ohlin (1899– 1979) on the basis of work by his teacher the Swedish economist Eli Fillip Heckscher (1879–1952). For his work on the theory, Ohlin was awarded the Nobel Prize for Economics in 1977. • Bertin Ohlin developed a new theory of international trade in 1933, in his famous book “Interregional and international trade", criticizing the classical theories of international trade. • This theory was given by Bertin Ohlin on the basis of his teacher Eli Fillip Heckscher's article “Pattern of international trade" published in 1919. • This theory is also known as modern theory of international trade, factor endowment theory, factor proportion theory of international trade, and 2x2x2 model of international trade.
- 4. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: ASSUMPTIONS • There are two countries and two commodities and two factors of production. • There are quantitative differences in factor endowments in different regions, but qualitatively they are homogenous. • Production functions of the two commodities have different factor intensities, that is labour intensive and capital intensive. • Production functions are different for different commodities but are same for each commodity in both countries. • There is perfect mobility of factors within each region but internationally they are immobile. • There are constant returns to scale in the production of each commodity in each region.
- 5. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: ASSUMPTIONS • Preference of consumers and their demand pattern are identical in both countries. • There is no change in technical knowledge. • There is perfect competition in commodity market and factor markets both. • There is full employment of resources. • There is no cost of transportation between the countries • Trade between two countries is free and unrestricted.
- 6. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: EXPLANATIONS • Heckscher-Ohlin theory, in economics, a theory of comparative advantage in international trade according to which countries in which capital is relatively plentiful and labour relatively scarce will tend to export capital-intensive products and import labour-intensive products, while countries in which labour is relatively plentiful and capital relatively scarce will tend to export labour-intensive products and import capital-intensive products. • Thus here Prof. Ohlin is focused on factor proportions and explains his theory on the basis of these two criteria, Physical criterion and price criterion.
- 7. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: EXPLANATIONS • Physical criterion:- • According to physical criterion, a country is said to be relatively capital abundant if it is endowed with a high proportion of capital to labour than in the other country. In other words ,a country is capital rich if the following conditions holds: • KA > KB LA LB • KA = Capital in Country A • LA = Labour in Country A • KB = Capital in Country B • LB = Labour in Country B
- 8. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: EXPLANATIONS • Price criterion:- • According to physical criterion, a country having capital relatively cheap and labour relatively dear is capital abundant country irrespective of the ratio of the quantity of capital to quantity of labour compared with other country: country A will now be capital rich compared with country B if, • (PK) < (PK ) (PL) (PL) • PK = Price of Capital • PL = Price of Labour • (PK) = (PK ) Trade is not possible (PL)A (PL)B
- 10. Y Y X X E D H N R B2 A B A’ B’ C K M T G L S Labour Capital B1 O X Y
- 11. FACTOR ENDOWMENT THEORY OF INTERNATIONAL TRADE: LIMITATIONS • Assumption of 2x2x2 is not possible. • Wrong assumption of preference of consumers and their demand pattern are identical in both countries. • Ignore role of product differentiation • Given more importance to supply of factors of production • Homogeneous factors of production • Identical production function • Transportation cost • There is no change in technical knowledge. • There is full employment of resources. • Trade between two countries is free and unrestricted.