This model is part of
trade theory economics. It is used in understanding how
factors of production are allocated in two countries that trade with each other. Under this model economists assume the following:
- There are two countries, two homogenous goods, and two homogenous factors of production (capital and labor, each in fixed supply in each country. The ratio of capital to labor (K/L) in one country is different form the K/L ratio in the other country.
- Technology is identical in both countries; that is, production functions are the same in both countries.
- There are constant returns to scale for both goods.
- One good is always capital-intensive (at any wage-price ratio), and the other is always labor-intensive.
- Aggregate preferences are exactly the same in both countries (so that, faced with the same relative price, one country will consume the two goods in exactly the same proportions as in the other country).
- Markets in goods and factors are perfectly competitive.
- Factors are perfectly mobile within each country and not mobile between countries.
- There are no transportation costs or barriers to trade.
These assumptions imply that each country will export the good which uses intensively the factor in which the country is abundant.