(a) Assume a two-country world with two factors of production (capital and labor

Question

(a) Assume a two-country world with two factors of production (capital and labor) and two goods. In this context, state the Heckscher-Ohlin theorem. Then indicate the two definitions of relative factor abundance. In addition, spell out what is meant by the assumption that one good is always relatively capital-intensive in its production process and the other good is always relatively labor-intensive in its production process. (b) Illustrate and carefully explain the complications that are generated for the predictive ability of the Heckscher-Ohlin theorem regarding trade patterns when (i) the phenomenon of “demand reversal” exists and (ii) the phenomenon of “factor-intensity reversal” exists.

Explanation / Answer

According to Hecksher Ohlin theorem a country which is relatively labour abandunt will export labour intensive good and the country who is capital abandunt will export capital intensive commodity.

But the assumption of this theorem is both the countries are identical except factor intensity.

The country which has more capital than other country is capital abandunt country and the country which has more labour than the other is labour abandunt country.

Now suppose two goods A and B. To produce A we need more capital and to produce B we need more labour.So process of producing A is capital intensive and process of producing B is more labour intensive.

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