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International Business

notes Fill in the blanks:
4. ............... maintained that the way a nation became rich and powerful was to export more
than it imported.
5. According to ..............., trade between two nations is based on absolute advantage.

2.4 relative factor endowment theory

Two Swedish economists Eli Heckscher and Bertil Ohlin developed the factor proportion theory
of international trade, also known as the modern theory of international trade. Modern Theory of
International Trade was propounded by Heckscher in an article published in 1919. It was further
improved upon by his student Bertil Ohlin in a research paper published in 1924 and later in his
book “International and Inter-regional Trade” published in 1933. This theory does not contradict
Comparative Cost Theory of International Trade, rather supports it. According to Comparative
Cost Theory, international trade takes place because of difference in comparative costs. But
it throws little light on the factors accounting for the difference in comparative costs. On the
contrary, modern theory of international trade reveals the causes responsible for difference in
the international trade.

statement of the theory

According to this theory, there is difference in factor endowments among different countries
of the world. For instance, certain countries have comparatively large supply of labour while
in others the supply of capital is relatively large. Because of difference in factor endowments
there is difference in the prices of the factors. Difference in the prices of the factors depends
on their relative scarcity or abundance. Owing to difference in the prices of the factors, there is
difference in the costs of the goods. Hence, this theory states that the main cause of difference in
comparative costs is the difference in factor endowment. Thus, international, trade takes place
because of diversity in factor endowments and hence difference in prices. Each country will
export that commodity in the production of which such factor is used whose supply is relatively
abundant and price is relatively cheaper. On the other hand, it will import that commodity in the
production of which that factor is used whose supply is relatively scarce and price is relatively
dearer. According to this theory, conditions of supply alone determine the pattern of international
trade. BO Sodersten, writes that
“Some countries have much capital, others have much labour. The theory now says that countries that are
rich in capital will export capital intensive goods and countries that have much labour will export labour
intensive goods”.

Definitions

In the words of Salvatore, “The Heckscher-Ohlin Theory states that difference in relative factor
endowments and factor prices between nations is the most important cause of trade. This theory predicts
that each nation will export the commodity in the production of which a great deal of relatively abundant
and cheap factor is used and import the commodity in the production of which a great deal of its relatively
scarce and expensive factor is used. The theory also predicts that trade will lead to the reduction in the
difference in factor prices between nations. “
According to Ohlin, “Immediate cause of inter-regional trade is always that goods can be bought cheaper
in terms of money than they can be produced at home and here is the case of international trade.”

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