Page 39 - DMGT545_INTERNATIONAL_BUSINESS

International Business

notes In USA, capital cost of production of watches or of shirts is equal to OF, but labour cost of shirts
is ON . While labour cost of watches is ON.
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Implying that labour cost of shirts is more by NN (ON – ON = NN ) units of labour.
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Thus, USA can produce watches at relative lesser cost, compared to the production of shirts.
In case of India, isocost line ZT and isoproduct curve WW for watches are tangent at point R.
So that, for India,
Product Cost of 100 Watches = ON Capital + OX Labour
Likewise isocost line Z T and isoproduct curve SS for shirts are tangent at point EI. So, that,
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Product Cost of 100
Shirts = OT Capital + OX Labour
Thus, in India, labour cost of watches and shirts = OX but capital cost of shirts is less than the
capital cost of watches by NT capital (ON – OT = NT). This suggests that India can produce shirts
at lesser cost compared to watches. Therefore, India should specialize in the production of shirts
and export the same.
It is thus, suggested that because capital is relatively cheaper in USA and because labour is
relatively cheaper in India, USA should specialize in the production of capital-intensive goods
i.e., watches and India should specialize in the production of labour-intensive goods i.e., shirts.
USA will export watches to India, while India will export shirts to USA.

Physical criterion of relative factor endowment

Physical criterion of factor abundance or scarcity means that if in a country capital ratio is greater
than labour as against another country, then it will be called capital intensive country. Likewise,
if in a country labour ratio is greater than capital as against another country, then it will be called
labour intensive country. In other words, basis of this criterion is the physical quantity of the
factors. On the basis of this criterion, international trade can be explained with the help of the
following example.

Example:
Example: According to Heckscher-Ohlin whether two countries, say USA and India, are capital
intensive or labour intensive depends on the fulfilment of the following condition:

Ku > Ki
L u L i

(Here K = Quantity of Capital in USA; L = Quantity of Labour in USA; K = Quantity of Capital
u
u
i
in India; L = Quantity of Labour in India)
i
USA will produce capital intensive and India, labour intensive goods. It is illustrated in the
following figure. GG is the production possibility curve of USA and II is the production
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possibility curve of India.
Labour intensive production, i.e., shirts, is shown on OX-axis and capital intensive production,
i.e. watches, is shown on OY-axis. If both the countries produce both the goods in the same ratio,
then they will produce along OR-ray. USA will produce at point E of its production possibility
curve GG and India will produce at point F of its production possibility curve II . It is evident
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from this figure that at point E, the slope of production possibility curve of USA is steeper and
at point F while the slope of production possibility curve of India is flatter. It is clear from the
fact that P P price line of USA is steeper than P P price line of India. It proves that watches are
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cheaper in USA and shirts are cheaper in India. USA should produce more of capital intensive
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