Marketing

The factor proportions model was originally developed by two Swedish economists, Eli Heckscher and his student Bertil Ohlin in the 1920s. Many elaborations of the model were provided by Paul Samuelson after the 1930s and thus sometimes the model is referred to as the Heckscher-Ohlin-Samuelson (or HOS) model. In the 1950s and 60s some noteworthy extensions to the model were made by Jaroslav Vanek and so occasionally the model is called the Heckscher-Ohlin-Vanek model. Here we will simply call all versions of the model either the "Heckscher-Ohlin (or H-O) model" or simply the more generic "factor-proportions model".

The H-O model incorporates a number of realistic characteristics of production that are left out of the simple Ricardian model. Recall that in the simple Ricardian model only one factor of production, labor, is needed to produce goods and services. The productivity of labor is assumed to vary across countries which implies a difference in technology between nations. It was the difference in technology that motivated advantageous international trade in the model.

The standard H-O model(1) begins by expanding the number of factors of production from one to two. The model assumes that labor and capital are used in the production of two final goods. Here, capital refers to the physical machines and equipment that is used in production. Thus, machine tools, conveyers, trucks, forklifts, computers, office buildings, office supplies, and much more, is considered capital.

All productive capital must be owned by someone. In a capitalist economy most of the physical capital is owned by individuals and businesses. In a socialist economy productive capital would be owned by the government. In most economies today, the government owns some of the productive capital but private citizens and businesses own most of the capital. Any person who owns common stock issued by a business has an ownership share in that company and is entitled to dividends or income based on the profitability of the company. As such, that person is a capitalist, i.e., an owner of capital.

The H-O model assumes private ownership of capital. Use of capital in production will generate income for the owner. We will refer to that income as capital "rents". Thus, whereas the worker earns "wages" for their efforts in production, the capital owner earns rents.

The assumption of two productive factors, capital and labor, allows for the introduction of another realistic feature in production; that of differing factor-proportions both across and within industries. When one considers a range of industries in a country it is easy to convince oneself that the proportion of capital to labor used varies considerably. For example, steel production generally involves large amounts of expensive machines and equipment spread over perhaps hundreds of acres of land, but also uses relatively few workers. In the tomato industry, in contrast, harvesting requires hundreds of migrant workers to hand-pick and collect each fruit from the vine. The amount of machinery used in this process is relatively small.

In the H-O model we define the ratio of the quantity of capital to the quantity of labor used in a production process as the capital-labor ratio. We imagine, and therefore assume, that different industries, producing different goods, have different capital-labor ratios. It is this ratio (or proportion) of one factor to another that gives the model its generic name: the factor-proportions model.

In a model in which each country produces two goods, an assumption must be made as to which industry has the larger capital-labor ratio. Thus, if the two goods that a country can produce are steel and clothing, and if steel production uses more capital per unit of labor than is used in clothing production, then we would say the steel production is capital-intensive relative to clothing production. Also, if steel production is capital-intensive, then it implies that clothing production must be labor-intensive relative to steel. MORE INFO

Another realistic characteristic of the world is that countries have different quantities, or endowments, of capital and labor available for use in the production process. Thus, some countries like the US are well-endowed with physical capital relative to its labor force. In contrast many less developed countries have very little physical capital but are well-endowed with large labor forces. We use the ratio of the aggregate endowment of capital to the aggregate endowment of labor to define relative factor abundancy between countries. Thus if, for example, the US has a larger ratio of aggregate capital per unit of labor than France's ratio, we would say that the US is capital-abundant relative to France. By implication, France would have a larger ratio