Heckscher and Ohlin theory, given by Swedish Economists Eli Hecksher and Bertil Ohlin, is an extension of theory of comparative advantage.
This theory introduces a second factor of production that is capital. This theory also states that comparative advantage occurs from differences in factor endowments between the countries.
Factor endowment refers to the amount of resources, such as land, labor, and capital available to a country.
Every country has different factor endowments, thus the costs of these factors differ depending upon their availability. For example, if a country has abundant labor, then the cost of labor would be low in that country.
According to Heckscher and Ohlin theory, a country would export products, which it produces by using the abundant factor of production. However, it would import goods, which require use of scarce resources. Countries trade with each other because they have different factor endowments.
For instance, some countries may have more labor and less machinery and some may have more machinery and less labor. In such a case, the country with more labor would specialize in labor-intensive products and export those products to other country.
The assumptions of Heckscher and Ohlin theory’ are as follows:
a. Needs of citizens of the two countries are same
b. Transportation cost between the countries is zero
c. Factors of production in both the countries are immobile
d. Factors of production in both the countries are not available in same proportion
The Heckscher and Ohlin theory shows relationship among various variables. The prices of the factors are determined by their availability, which further determines the price of the product. Cost advantage and specialization occurs as a result of difference of factor prices and product price.