ABSTRACT
Chapter 3 develops a theory to explain why relative costs and prices differ across countries and how these differences lead to mutually beneficial trade when more than one factor of production exists. The Heckscher-Ohlin theory and its related theorems make several assumptions about the trading environment. A 2×2×2 framework characterizes the model. This means that two countries, two goods, and two factors of production exist. Technology differs between the two goods but is identical across countries. The model also assumes the level of technology to be fixed. Constant returns to scale exist in both industries, meaning if labor and capital inputs are exactly doubled, total output exactly doubles. Factor intensity reversals do not exist. In other words, commodities can be unambiguously ranked according to factor intensity. For example, if wheat production requires a higher ratio of labor to land than does the manufacture of cloth, we can conclude that wheat is labor intensive. A lack of factor intensity reversals implies wheat’s greater labor intensity relative to steel holds for all possible wage rate to land price ratios.
