The Heckscher-Ohlin theory explains why countries trade goods and services with each other, the emphasize being on the difference of resources between two countries. The theory presents the issue that international and interregional differences in production costs occur because of the differences in the supply of production factors. Factors of production include labour, capital, land, human resources, technology etc. Factor endowments vary among countries. Products differ according to the types of factors that they need as inputs.
A country has a comparative advantage in producing products that intensively use factors of production (resources) it has in abundance. Countries such as Australia with relatively large amounts of land do export land intensive products (eg. grain and cattle); whereas a country like China would export labour intensive products. The price of a commodity is determined by the demand for and supply of it, i.e., the preferences and incomes of consumers, on the one hand, and production possibilities on the other. According to this theory, what needs to be reached is; ‘the point of equilibrium’, at which, the demand and supply will be equal to each other and the price of commodity equals its cost of production per unit.
The Opportunity Cost Theory
Ottfied Haberler propounded this theory in 1959 as a reaction to the theory of comparative advantage. This theory specifies the cost in term of the value of the alternatives which have to be foregone in order to fulfill a specific act. This theory builds up the foundation for international trade in the process of exporting a specific product rather than other products. For example, if a city decides to build a hospital on vacant land it owns; the opportunity cost is the value of the benefits forgone of the next best thing which might have been done with the land and construction funds instead. In building the hospital; the city has forgone the opportunity to build a sports Centre on that land, or a parking lot.
The Product Cycle Theory
The product life-cycle theory is an economic theory that was developed by Raymond Vernon in response to the failure of the Heckscher-Ohlin model; to explain the observed pattern of international trade. The theory suggests that early in a product’s life-cycle; all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. In some situations, the product becomes an item that is imported by its original country of invention. A commonly used example of this is the invention, growth and production of the personal computer with respect to the United States.
There are five stages in a product’s life cycle:
- Introduction of the product in the domestic market,
- Growth of the product in the domestic market,
- Demand for and export of the product in the foreign markets,
- Maturity of the product in the foreign markets, and
- Decline of production of the product in the original country because its production has started in the export markets.
The theory does have its disadvantages. Perhaps the most recognizable is the assumption that products are released initially in the domestic markets. Many globalized companies tend to release their new product lines internationally, not domestically; hence this theory cannot be applied to many of today’s products.
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Written By: Abhishek Khare Advocate