Understanding the Heckscher-Ohlin Model

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HECKSCHER-OHLIN MODEL The Heckscher-Ohlin is an expansion of the Ricardian model. The H-O model incorporates a number of realistic characteristics of production that are left out of the simple Ricardian model. The HO model differs from the Ricardian model along two dimensions. Firstly, it adopts a more realistic framework as compared to Ricardian model by allowing for two factors of production; labor and capital. Secondly, in the Heckscher-Ohlin model comparative advantage is determined by differences in endowments of factors across countries assuming production technology to be the same. The first innovation implies that the production possibility frontier is going to be concave and hence result in increasing opportunity costs. As a result, …show more content…

In addition to the usual basic assumptions (no transport costs, free trade, perfect competition, international immobility of factors) there are the following: 1. The production functions exhibit positive but decreasing returns to each factor (i.e., positive but decreasing marginal productivities) and constant returns to scale (i.e., first degree homogeneity). They are internationally identical, but, of course, different between the two goods, that is the production function of iron ore is the same in India and China , and is different from that of mobile phones (which is identical in the two countries). 2. The structure of demand, that is the proportions in which the two goods are consumed at any given relative price, is identical in both countries and independent of the level of income i.e. the preferences are homothetic. 3. Factor-intensity reversals are excluded. In the previous section of our paper, we have shown how there is a redirection of FDI inflow to India from China. This FDI is taken in this model as capital investment(increase in capital for India and an equal decrease of capital from China). The following table shows the data of labor force and capital investment in terms of machinery and other …show more content…

Solving the above two equations, we get ; (2) ; (3) China is losing the inflow of FDI to India. This can be seen as a reduction in KO such that From (2), From (3), This results in a decrease of production of mobile phones and an increase in the production of iron ore. Since mobile phones are finished goods and iron ore is a raw material, mobile phones garner more revenue in an economy and thus decrease in its production results in GDP loss for China. This FDI that China loses to India results in an unbiased growth of factor endowments i.e. they are increasing at the same rate Thus, we can write (2) and (3) as (Substitute QM = QI = 1 Since India is a labor surplus economy, LO > KO ) Thus, in unbiased growth, capital-intensive sector grows at a faster rate than labor-intensive sector and since capital-intensive sector is a more revenue garnering sector, India gains from this unbiased growth in factor endowments seen due to the FDI redirection from

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