The Heckscher-Ohlin Model

The Heckscher-Ohlin Model

Udayan Roy http://myweb.liu.edu/~uroy/eco41

BASIC ASSUMPTIONS

The Heckscher-Ohlin Assumptions— Basics

• There are

– two countries, Home and Foreign – two goods, Cloth and Food, and – two resources, Labor and Capital

• these are used to produce Cloth and Food

The Heckscher-Ohlin Assumptions— Preferences

• The preferences of all consumers in the world are identical. • The preferences of any individual are such that the Marginal Rate of Substitution is independent of the scale of consumption.

– The MRS of Wine for Cheese is the additional amount of Wine that would keep the individual's level of happiness unchanged even after the consumption of Cheese is reduced by one unit. Under this assumption, if the amounts of Cheese and Wine being consumed are, say, doubled, then the MRS remains unchanged. In other words, the MRS does not change if the ratio of the amounts of Cheese and Wine consumed, Cheese/ Wine, does not change.

The Ricardian Assumptions— Preferences

• The preferences of all consumers in the world are identical. • For any individual, the Marginal Rate of Substitution is independent of the scale of consumption.

– An individual’s MRS of wine for cheese is the maximum amount of wine that he/she would be willing to pay for one unit of cheese. – Under this assumption, if the amounts of Cheese and Wine being consumed are, say, doubled, then the MRS remains unchanged. – In other words, the MRS does not change if the ratio of the amounts of Cheese and Wine consumed, Cheese/ Wine, does not change.

Marginal Rate of Substitution

Cheese consumed (C) 10 600 10 Wine consumed (W) 20 1200 5 CheeseWine Ratio (C/W) 0.5 0.5 2 MRSWC

2 2 1.6

The Heckscher-Ohlin Assumptions— Markets

• All markets are perfectly competitive.

– That is, no buyer or seller of a commodity has the power to affect the price of the commodity by himself. – More specifically, the market for a commodity is said to be perfectly competitive if:

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