WELCOME TO OUR

PRESENTATION

PRESENTED TO:MAM AMMARA

HAILEY COLLEGE OF COMMERCE

UNIVERSITY OF THE PUNJAB

PRESENTED BY:GROUP-01

GROUP: 1Sr.no Roll no. Name of student1 BC14-053 Naghmana Hamid2 BC14-077 Zartashia Munir3 BC14-058 Fatima Rahim4 BC14-070 Amna Munawar5 BC14-051 Areesha Akram

TOPIC:MODERN THEORY OF INTERNATIONAL TRADE

THE HECKSCHER-OHLIN THEOREM

NAGHMANA HAMIDBC14-053

WHAT IS INTERNATIONAL TRADE THEORY:

The Exchange of Capital, Goods and Services,

across international borders is called international trade.

Exchange of Goods and Services along international borders is called international trade.

Modern theory of international trade is also called Theory of factor endowments.

According to this theory, one condition for trade is that countries differ with respect to the availability of the factors of production.

The Heckscher-Ohlin theory focuses on the two most important factors of production:

labor and capital.

Hecksher-Ohlin Theory

“A Nation Exports the commodity whose production

requires the abundant factor intensively & imports

the commodity whose production is intensive in the

scarce factor of the country”

DEFINITION:

UNDERSTANDING THE CONCEPT OF FACTOR ABUNDANCE:

THE 2X2X2 MODEL OF TWO COUNTRIES, TWO COMMODITIES & TWO FACTOR MODEL, IMPLIES THAT THE CAPITAL RICH COUNTRY WILL EXPORT CAPITAL INTENSIVE COMMODITY AND THE LABOR RICH COUNTRY WILL EXPORT LABOR INTENSIVE COMMODITY.

AREESHA AKRAMBC14-051

1) There are two nations (1&2), two commodities (X&Y), two factors of production (labor & capital).

Used to illustrate the theory in a two-dimensional figure.

2) Both nations use the same technology in production.Means both nations have access to and use the same general production techniques.

3) Commodity X is labor intensive and Y is capital intensive in both nations. Means the labor-capital ratio (L/C) is higher for X than Y in both nations at the same

relative factor prices.

Assumptions of the Theory

4) BOTH COMMODITIES ARE PRODUCED UNDER CONSTANT RETURNS TO SCALE IN BOTH NATIONS.

MEANS THAT INCREASING THE AMOUNT OF L AND C WILL INCREASE OUTPUT IN THE SAME PROPORTION

5) THERE IS INCOMPLETE SPECIALIZATION IN PRODUCTION IN BOTH NATIONS.

MEANS THAT EVEN WITH FREE TRADE BOTH NATIONS CONTINUE TO PRODUCE BOTH COMMODITIES. THIS IMPLIES NEITHER NATION IS VERY SMALL.

6) TASTES ARE EQUAL IN BOTH NATIONS.

MEANS DEMAND PREFERENCES ARE IDENTICAL IN BOTH NATIONS. WHEN RELATIVE PRICES ARE EQUAL IN THE TWO NATIONS, BOTH CONSUME X&Y IN THE SAME PROPORTION.

7) THERE IS PERFECT COMPETITION IN BOTH COMMODITIES AND FACTOR MARKETS IN BOTH NATIONS.

MEANS THAT PRODUCERS, CONSUMERS, AND TRADERS OF X&Y IN BOTH NATIONS ARE EACH TOO SMALL TO AFFECT PRICES OF COMMODITIES.

8) THERE IS PERFECT FACTOR MOBILITY WITHIN EACH NATION BUT NO INTERNATIONAL FACTOR MOBILITY.

MEANS C&L ARE FREE TO MOVE FROM AREAS AND INDUSTRIES OF LOWER EARNINGS TO THOSE OF HIGHER EARNINGS UNTIL EARNINGS ARE THE SAME IN ALL AREAS, USES AND INDUSTRIES OF THE NATION. INTERNATIONAL DIFFERENCES IN EARNINGS PERSIST DUE TO ZERO INTERNATIONAL FACTOR MOBILITY IN THE ABSENCE OF INTERNATIONAL TRADE.

9) THERE ARE NO TRANSPORTATION COSTS, TARIFFS, OR OTHER OBSTRUCTIONS TO THE FREE FLOW OF INTERNATIONAL TRADE.

MEANS SPECIALIZATION IN PRODUCTION PROCEEDS UNTIL RELATIVE (AND ABSOLUTE) COMMODITY PRICES ARE THE SAME IN BOTH NATIONS WITH TRADE. IF TRANSPORTATION COSTS AND TARIFFS WERE ALLOWED, SPECIALIZATION WOULD PROCEED ONLY UNTIL PRICES DIFFERED BY NO MORE THAN THE COSTS AND TARIFFS ON EACH UNTIL OF THE COMMODITY TRADED.

10) All resources are fully employed in both nations.Means there are no unemployed resources in either nation.

11) International trade between the two nations is balanced. Means that the total value of each nation’s exports equals the total value of the

nation’s imports.

ZARTASHIA MUNIR

BC14-077

EXPLANATION:

• Suppose nation 1 is labor abundant nation and nation 2 is capital abundant nation.

•Let production of product X be labor intensive and that of product Y is capital intensive.

•The PPF’s shown in following figure show the max. limit of production of X & Y, possible with given resources.

FIGURE :The Shape of the Production Frontiers of Nation 1 and Nation 2.

• FOR EXAMPLE, IF WE IMAGINE COMMODITY X IS LABOR INTENSIVE COMMODITY AND NATION 1 PRODUCES IT, ON THE OTHER HAND NATION-2 PRODUCES COMMODITY Y WHICH IS CAPITAL INTENSIVE COMMODITY. HERE L IS AVAILABLE AND CHEAP FACTOR IN NATION

1 AND SO IS K IN NATION 2.

• NOW H-O THEOREM SAYS THAT, NATION-1 WILL EXPORT X BECAUSE X

IS THE L-INTENSIVE COMMODITY AND L IS RELATIVELY ABUNDANT

AND CHEAP FACTOR IN NATION 1.

• NATION-1

AND NATION-2 WILL EXPORT Y BECAUSE Y IS THE K-INTENSIVE COMMODITY AND K IS RELATIVELY ABUNDANT AND CHEAP FACTOR IN NATION 2.

NATION-2

FATIMA RAHIMBC14-058

PRE AND POST-TRADE SITUATION:

• Before trade,both nations will have different price ratios of X & Y commodities such as PA and PA` respectively.

• Both nations must produce on their production possibility curve,where their repective price line is tangent to the production possibility curve.

• This happens at point A for nation 1 and on A` for nation 2, yet they are not trading, so consumption will be at the same points.

• There are no imports or exports.

• This concept is explained by following figure Left side panel.

Since the two nations have equal tastes, they face the same indifference map.Indifference curve I is the highest IC that Nation 1 and Nation 2 can reach in isolation, and points A and A/ represent their equal. points of production and consumption in the absence of trade.The tangency of IC I at points A and A/ defines the no-trade equal-relative commodity prices of PA in Nation 1 and PA/ in Nation 2. Since PA < PA/ , Nation 1 has a com-adv. in X and Nation 2 has a com-adv. in Y.

Right panel shows the after trade situation where nation 2 is producing capital intensive commodity Y & nation 1 is producing labor intensive commodity X, more than pre-trade situation.

Production of nation 1 & 2 are shown by points B & B` respectively. The point of consumption is E` on a higher Indifference curve.

Nation 1 exports X in exchange for Y and consume at point E on IC II. Nation 2 exports Y for X and consume at point E/ (which coincides with point E).Note that Nation 1’s exports of X equal Nation 2’s imports of X (i.e. BC=C / E /). Similarly, Nation 2’s exports of Y equal Nation 1’s imports of Y (i.e. B / C / =C E).

After the trade, both the countries will have both types of goods at the least cost.

As a result the welfare of both nations will be increased, as after trade they are consuming at a higher indifference curve.

AMNA MUNAWARBC14-070

LIMITATIONS OF THEORY: THE THEORY HOLDS GOOD IF THE CAPITAL ABUNDANT COUNTRY HAS A

DISTINCT PREFERENCE FOR THE LABOUR INTENSIVE GOODS AND THE LABOUR ABUNDANT COUNTRY HAS A DISTINCT PREFERENCE FOR CAPITAL INTENSIVE GOODS.

AGAIN THE THEORY DOES NOT HOLD GOOD IF THE LABOUR ABUNDANT COUNTRY IS TECHNOLOGICALLY ADVANCED IN CAPITAL INTENSIVE GOODS OR IF CAPITAL ABUNDANT ECONOMY IS TECHNOLOGICALLY ADVANCED IN THE PRODUCTION OF LABOUR INTENSIVE GOODS.