Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

(B) 
(A) 

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O
C
C
S
S
S
IC
1
2
1
2
2
Steel
Cotton
Figure 12.8 
 
Ps/Pc indicates the pre-trade price ratio. Production and 
consumption take place at the same point on production possibility 
frontier where it is tangent to the community in difference curves. 
As trade takes place the price ratio changes to 
Ps
Pc
Production is 
given by OS
2
of steel and OC
2
of cloth. Consumption of the two 
commodities stand at OS
2
and OC
2
respectively. S
2
-S represents 
the surplus in steel production over consumption and so it will be 
exported. Domestic consumption of cloth given by OC is clearly 
higher than domestic production equal to OC
2
OC- OC has to be 
imported from abroad. This is how production consumption and 
trade problems are solved in the Heckscher Ohlin model after 
trade. 
If price ratio should change further to the position production 
of steel would increase further in country indicating greater 
specialisation. But mostly it is incomplete specialisation in H-0 
model, a country will always produce two commodities exchanging 
surplus production of one commodity in favour of another. 
Complete specialisation would require that country one will produce 
only steel and exchange surplus production for cloth. 
Empirical testing: This theory was put to empirical 
verification by Leontief. In the year 1949 he collected samples from 
200 U.S. industries and wanted to see if exports use higher capital 
labour ratio compared to those in imports. To collect data from 
import industries Leontief did not actually visit the countries from 
which imports were made. He collected information from domestic 
import competing industries. The question he asked to the firms 
was like this: if imports are to be cut by $1 billion and domestic 
production is to increase by equal amount how much of additional 
labour and capital would be necessary. The same procedure was 
repeated in the case of export industries. Finally the result that he 
got completely upset the Heckscher Ohlin conclusion U.S exports 
were found to be using more labour relative to capital whereas 

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import competing sector was using more capital relative to labour. 
U.S.A. being traditionally known as a capital abundant country, this 
result was unexpected. 
Leontief took great pains in offering an explanation. He 
pointed out that US firms engaged in the production of an import 
replacing item followed its own technique of production. It was not 
necessarily the same as that followed in the countries from which 
imports were made. After trade when commodity price ratios 
change factor price ratio might have changed also. And the same 
level of output could be produced by using a different factor 
combination.