Page 56 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes (viz. HE = JE) but more labour (JF as against HF). This means that country A can produce K good
cheaper. Hence the capital surplus country (country A) would specialize in the production and exports
of capital-intensive good (K good). This is for country A.
Take the case of country B now. The cost of producing one unit of L good is made up of MG amount
of capital plus MT amount of labour, but the cost of producing one unit of K good consists of the same
amount of labour viz. NR (MT) but more amount of capital i.e. RG (as against MG needed to produce
one unit of K good). This means that country B can produce L good at a relatively lower cost of
production per unit. Therefore, country B (a labour surplus country) would specialize in the production
and exports of L good (a labour intensive good).
To sum up : (a) Factor price ratios in country A and B are different, which reflects that country A is
capital-abundant and country B is labour-abundant, (b) one commodity is capital intensive in both
the countries (viz. K good) and the other commodity is labour intensive in both the countries (L
good), because point J lies to the right of point H in country A, and in country B, point R lies to the left
of point M. (You may draw the vectors from points H, J, R and M to the point of origin, O, and you
will see the capital-labour ratios in the production of the two goods in the two countries. This is not
done in Figure 4.7 in order not to clutter the graph), and (c) country A can produce K good cheaper,
and country B can produce L good cheaper. Therefore, country A exports K good and country B
exports L good. The country which is relatively abundant in a given factor of production will export
a commodity which involves the use of a relatively abundant factor of production.
Thus, starting from the definition of factor abundance in terms of factor prices, (or price criterion) it
is easy to establish the Heckscher-Ohlin theorem. Incidentally, we might also say that reverse of the
theorem also holds good, i.e. if a country exports capital intensive good, then capital must be its
cheaper factor of production. Likewise, if a country exports labour-intensive good, then labour must
be a cheaper factor of production in that country.
Physical Criterion of Factor Abundance
Defining factor abundance in physical terms would mean that country A would be capital-abundant
and country B would be labour abundant if the following condition holds good :
 K A   K B 
  >  
 L A   L B 
where K and L are the total amounts of capital and labour, respectively, in country A, and K are L
A A B B
one the amounts of capital and labour, respectively, in country B.
We will now show that country A, a capital abundant country by the physical criterion of abundance,
has a bias in favour of producing the capital-intensive good; and that country B, a labour abundant
country will have a production bias in favour of labour-intensive good production. Diagram 8 reflects
the nature of these biases in the two countries in respect of the two goods.

A

P 1 R
Steel
Q 1
P 2 P
C 2 P
Q 2 1

O B Cloth D

Figure 4.8 : Factor abundance defined in physical terms.

50 LOVELY PROFESSIONAL UNIVERSITY