THE ISSUES

Factor substitution does not change the Heckscher–Ohlin model as much as it changed the Ricardian model. Its main effect is to alter the shape of the transformation curve. Instead of having two straight-line segments, it becomes a smooth curve, and every point becomes a full-employment output point. Nevertheless, the methods used to illustrate factor substitution allow us to explore more thoroughly some of the issues raised in earlier chapters:

• How factor endowments influence production and trade.

• How trade and tariffs affect the real earnings of the factors of production.

• How capital formation, population growth, and changes in technology affect production, trade, and economic welfare.

We begin by introducing the techniques needed to depict factor substitution in the Heckscher–Ohlin model.

ANOTHER WAY TO DEPICT FACTOR SUBSTITUTION

In the modified Ricardian model, labor was perfectly mobile within the economy, and firms were able to combine various amounts of labor with fixed amounts of land or capital. In the Heckscher–Ohlin model, both factors of production, labor and capital, are perfectly mobile, and firms are able to combine various amounts of labor with various amounts of capital.

The choices confronting an individual firm are described by isoquants like the curve IC in Figure 6-1. Each point on an isoquant defines a combination of labor and capital that can be used to grow a single bushel of corn. At Q, for example, the firm uses OL1 labor and OK1 capital.