RCA measures a country's exports of a commodity (or industry) relative.

total exports and to

the corresponding exports of a set of countries. comparative advantage is "revealed", if RCA
is bigger than one (RCA >1). and if RCA less than one (RCA < 1). the country is said to have
a comparative. Disadvantage in the commodity.

Lafay (1992). Trade Balance Index (TBI) is defined as the ratio between. export
and total traded goods (exports coupled imports). Trade Balance . Index explain
whether a country made net exporter or net imporer,The value of Trade Balance
index indicates a qualitative strucure of product. export and import trade flows.
which is formulated as:

TBlij represents the balance of trade index of country i for product j ,The value
of TBl index ranges between -1 and 1,When TBlij= 1 indicates that the
qualitative structure of exports above. structure of imports or a country as net
exporter. TBlij equals =-1 implies that a country as net importer. if the value of
TBI index with to zero. represents that the value of exports same as the value of
imports in the country i. For simplity interpretation of the index TBl. if index tbi
positive the mean as a net exporter and as a net importer when the index of tbi is
negative.
A. Assumptions of the Theory
The Assumptions :
1. There are two nations (182), two commodities (X&Y), two factors of
production (labor & capital).
2. Both nations use the same technology in production.
3. commodity X is labor intensive and Y is capital intensive in both nations.
4. Both commodities are produced under constant returns to scale in both
nations.
5. There is incomplete specialization in production in both nations.
6. Tastes are equal in both nations.
7. There is perfect competition in both commodities and factor markets in
both nations.
8. there is perfect factor mobility within each nation but no international
factor mobility.
9. There are no transportation costs, tariffs, or other obstructions to the free
flow of international trade.
10.All resources are fully employed in both nations.
11.International trade between the two nations is balanced.

Meaning of the Assumptions :

1. Made in order to illustrate the theory in a two- dimensional fiqure.

2. Means both nations have access to and use the same general production
techniques.
3. Means the labor-capital ratio (L/K) is higher for X than Y in both nations
at the same relative factor prices.
4. Means that increasing the amount of L and K will increase output in the
same proportion.
5. Means that even with free trade both nations continue to produce both
commodities. This implies neither nation is very small.
6. Means demand preferences are identical in both nations. When relative
prices are equal in the two nations, both consume X&Y in the same
proportion
7. Means that producers, consumers, and traders| X&Y in both nations are
each too small to affect prices of commodities. Also, in the L-R
commodities prices equal their costs, leaving no economic proportion
8. Means K&L are free to move from areas and industries of lower earnings
to those of higher earnings until earnings are the same in all areas uses
and industries of the nation. International differences in earnings persist
 due to zero international factor mobility in the absence of international
trade.
9. Means specialization in production proceeds until relative (and absolute)
commodity prices are the same in both nations with trade. If
transportation costs and tariffs were allowed, specialization would
proceed only until prices differed by no more than the costs and tariffs on
each until of the commodity traded.
10.Means there are no unemployed resources in either nation.
11.Means that the total value of each nation's exports equals the total value
of the nation's imports.

Figure 5-1 : Factor Intensities for commodities X and Y

 Nation 1 can produce 1X using 1K-4L. using 2K-8L Thus,K/L=1/4 this

give the slope of the ray of the X nation 1.
 In nation 2,K/L=4 for Y and 1 for X
 Therefore,Y is the K-intesive commodity and X is the L-intensive in
nasion 2 also.this is shown by the fack that the ray from the origin for
good Y is steeper than that of X in both nations.
 Even though Y is K-intensive relative to Xin both nations,nation 2 uses a
higher K/L that Nation 1
 For Y , K/L=4 in Nation 2 but K/L=1 in nation 1.
For X, K/L=1 in Nation 2 but K/L=1/4 in nation 1
B. Factor Abundance
Two way to define factor abudance:
1) in terms of physical units(i.e.overall amout of K&L (TK/TL) available to
each nation)
 According to this definition,Nation 2 is capital abundant if the ratio
of total amout of capital to total amout of labor available in Nation
2 is greater that in Nation 1
 The ratio of TK/TL what is important,not the absolute amount of
K&L available in each nation
 Thus , Nation 2 can have less K that Nation 1 and still be the
capital abundant nation if TK/TL in Nation 2 exceeds TK/TL in
Nation 1

2) in terms of relative factor prices (i.e. rental price of K(Pk) and the price
of L time (PL) in each nation)
 According to this definition,Nation 2 is K abundant if(P K/PL) is
lower in Nation 2 that in Nation 1
 Since rental price of K is taken to be the interest rate (r) and the
price of labor time is wage (w),then PK/PL= r/w
 The ratio r/w what is important , not the absolute lavel of r that
determines whether a nation is K abundant

The first definition considers only the supply of the factor,while the
second definition considers both demand and supply.
The Demand of the factor is derived from demand for the final
commodity that requires the factor in its production

Q: Why does Nation 2 use more K- intensive production techniques in both

commodities than Nation 1?
A: Capital must be relativelt cheaper in nation 2 that in Nation 1, so that
producers in nation 2 use relatively more capital in the production of both
commodities to minimize their cost of production.
Q: But why is capital relatively cheaper in Nation 2?
A: We must define factor abundance and examine its relationship to factor
prices.
If the price of capital fall, producer would subtitute capital for labor in
production of X&Y to minimize production cost,As a result,both commodities
become K-intensive.if K/L of Y exceeds K/L of X, Y is considred a K-intensive
commodity.
C. Factor Abundance and the Shape of the Production Frontier

 Since Nation 2 is K-abundant and Y is K-intensive,Nation 2 can produce

relatively more of Y than Nation 1.
 Since Nation 1 is L-abundant and X is L-intensive,Nation 1 can produce
relatively more of X than Nation 2
 This gives a production frontier for Natin 1 that is relatively flatter and
wider that that of Nation 2

J
Figure 5-2: The Shape of the Production Frontiers of Nation 1 and Nation 2

5.3 Factor Intensity,Factor Abudance, and the Shape of the Production

Frontier (PF)
Factor Intensity :

 In a world of 2 commodities and 2 factors,Y is capital intensive if its

(K/L) is greater than (K/L) of X.
 If production of Y requires 2K and 2L,then K/L=1
 If production of X requires 1K and 4L,then K/L=1/4
 We say that Y is K intensive and X is L intensive
 Measuring K and L intensity depends on K/L rather that the absolute
amout of K and L
 In figure 5-1.Nation 1 can produce 1Y using 2K-2L,and 2Y using 4K-
4L,Thus ,K/L=1,this gives the slope of Y in Nation 1

5.4 Factor Endowments and the Heckscher-Ohlin Theory

In 1919 Eli Heckscher published “The Effect of Foreigh Trade in the

Distribution of Income”
In 1933 Berlin Ohlin published “Interregional and internasional
Trade”in which he clarified and built on the work of Hecksher
 The H-O theory can be present in the form of two theorems; the H-O
theorem (which deals with and predicts the pattern of trade) and the
factor-price-equalization theorem (which deals with the effect of
international trade on factor prices)

The Heckscher-Ohlin Theorem :

Definition: A nation will export commodity whose production requires the

intensive use of the nation’s relative abundant and cheap factor and import the
commodity whose production requires the intensive use of the nation’s
relatively scare and expensive factor or : the relatively labor-rich nation export
the relatively labor-intensive commodity and imports the relativelt capital-
intensive commodity

 This means that Nation 1 export X because X is the L-intensive

commodity and L is relatively abundant and cheap factor in nation 1
 Nation 2 Exports Y because Y is the K-intensive commodity and K is
relatively abundant and cheap factor in nation 2

The H-O theorem isolates the diffrences in relative factor abundance,or factor
endowments,among nation as the basic cause of comparative advantage and
internasional trade.For this reason,it is known as factor –proportion or factor
endowment theory.It postulates that the difference in relative dactor abudance
and prices is the cause of pretrade diffrence in relative commodity prices
between two nation

Illustration of Theory :
Since the two nation have equal tastes,they face same inifference
map.Indifference Curve I is the highhest IC that Naton 1 and Nation 2 can
reach in isolation, and point a and Al defines the no- trade equilibrium-relative
commodity prices of PA in Nation 1 and PAl in Nation 2.Since PA<PAl,Nation 1
has comparative advantage in X and Nation 2 has comparative advantage in Y.
FACTOR ENDOWMENTS & TRADE PATTERS

taste matter? Or superior goods?

If both countries have the same tastes,demand curves are DD.USA,being

heavily capital endowed,has supply curve further to right.Hernce,USA exports
& ROW Imports the good.But if higher USA income (or stronger tastes)
determine the USA demand curve DS:DS,USA will import the good & export
the other,labor intensive good.