Factor Price Equalization

12 Key excerpts on "Factor Price Equalization"

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  Lecture Notes on International Trade Theory and Policy

  • Richard Pomfret(Author)
  • 2008(Publication Date)
  • WSPC

    (Publisher)

  The argument is logically impeccable, given the assumptions; unless there is a size discrepancy which leads to a little country becoming completely specialised before factor prices are equalised. The factor price equalisation theorem follows from the point, made in Chapter 4, that in the neoclassical model there is only one degree of freedom; once one set of relative prices or outputs is fixed, the rest are determined endogenously. Robert Mundell (1957) proved the International Trade and the Distribution of Income 47 corollary: if factors could move freely across borders so that relative factor prices were the same everywhere, then there would be a pro-cess of goods price equalisation even in the absence of trade in goods. In the neoclassical general equilibrium model with no deviations from perfect competition other than the inability of either goods or factors to cross borders, there are both goods price equalisation and factor price equalisation. The factor price equalisation theorem is less robust than the Stolper–Samuelson theorem because it requires a more restrictive set of assumptions. In the presence of any differences in produc-tion functions or barriers to the movements of goods, the factor price equalisation theorem will not hold. Mundell observed that the real world outcome would be convergence rather than equali-sation. Convergence is likely to be greater in some goods markets (e.g. homogeneous goods with low weight-to-value ratios such as gold or diamonds) than others (e.g. differentiated products whose prices are hard to compare). Despite its failure to explain interna-tional differences in factor rewards, especially the wide disparities in incomes between rich and poor countries, the factor price equali-sation theorem may be useful as a pointer to long-term tendencies.

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  Handbook of International Economics

  • G.M. Grossman, Kenneth Rogoff(Authors)
  • 1997(Publication Date)
  • North Holland

    (Publisher)

  Labels are important since they can influence the conversation in important but unfelt ways. For example, when we call trade barriers “protection” and estimators “unbiased”, our critical attitudes can diminish. Likewise when we name a result the “Factor Price Equalization” theorem, it is unsurprising that most of us have the impression that it deals with the international equalization of factor prices. Indeed it does, but only as a corollary. A more accurate name for conveying the true meaning of the result would be the Factor Price Insensitivity theorem, which contrasts in important ways with FPE.

  Factor Price Insensitivity theorem (FPI): Within a country, factor prices are altogether insensitive to changes in factor supplies, holding product prices fixed.

  Factor Price Equalization theorem (FPE): Factor prices are the same in different countries.

  Another way of stating the Factor Price Insensitivity theorem is that the demand for labor in an open economy is infinitely elastic. This requires that factor supply variation is too small to take the country into a different cone of specialization. Factor Price Equalization is a corollary requiring the additional and unlikely trio of assumptions: identical technologies, identical product mixes and no factor intensity reversals.

  In addition to deflecting our attention away from the empirically more relevant FPI theorem, the traditional way of expressing FPE hides its real message. The message isn't that factor prices are equalized, or even that they are insensitive to variation in factor supplies. The message is the mechanism, namely variation in the mix of output. There might well be other mechanisms to achieve the same results, but both FPE and FPI rely on changes in the composition of output, and these results should be judged to be empirically invalid if there is no evidence that the mix of output depends on factor supplies.

  Furthermore, like any other arbitrage condition, both FPI and FPE are conditions that necessarily take some time to hold, if they hold at all. Although the theories make no explicit reference to time, we all understand what is really being asserted: arbitrage works rapidly enough so that in the vast vibrating real economy we can “see” the force of arbitrage at work.

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  Handbook of International Trade

  • E. Kwan Choi, James Harrigan, E. Kwan Choi, James Harrigan(Authors)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  American Eco-nomic Review , 58, 1248–68. Melvin, James and R. Warne 1973: Monopoly and the theory of international trade. Journal of International Economics , 3, 117–34. Minabe, Nubuo 1967: The Stolper–Samuelson theorem, the Rybczynski effect, and the Heckscher–Ohlin theory of trade pattern and Factor Price Equalization:The case of a many-commodity, many-factor country. Canadian Journal of Economics and Political Science , 33, 401–19. Mokhtari, Manoucher and Farhad Rassekh 1989: The tendency towards factor price equal-ization among OECD countries. The Review of Economics and Statistics , 61, 636–42. Murphy, Kevin and Finnis Welch 1992: The role of international trade in wage differentials. In Marvin Kosters (ed.), Workers and Their Wages: Changing Patterns in the US , Washington: AEI Press. Neary, Peter 1985: Two-by-two international trade theory with many products and factors. Econometrica , 53, 1233– 47. Panagariya, Arvind 1983:Variable returns to scale and the Heckscher-Ohlin and factor-price-equalization theorems. Weltwirtshaftliches Archiv , 119, 259–79. Panagariya, Arvind 2000: Evaluating the factor content approach to measuring the effect of trade on wage inequality. Journal of International Economics , 30, 91–116. Pearce, Ivor 1951: The Factor Price Equalization myth. Review of Economic Studies , 19, 111–19. 82 Henry Thompson Rader,Trout 1979: Factor price equilibrium with more industries than factors. In Jerry Green and José Sheinkman (eds.), General Equilibrium, Growth, and Trade , New York: Academic Press. Rassekh, Farhad 1993: International trade and the relative dispersion of industrial wages and production techniques in fourteen OECD countries, 1970–1985. Open Economics Review , 4, 325–44. Rassekh, Farhad and Henry Thompson 1997: Adjustment in general equilibrium: Some indus-trial evidence. Review of International Economics , 5, 20–31. Rassekh, Farhad and Henry Thompson 2002: Measuring factor abundance across many factors and many countries.

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  Uncertainty and the Theory of International Trade

  • E. Grinols(Author)
  • 2013(Publication Date)
  • Taylor & Francis

    (Publisher)

  let condition a or b hold. Then Factor Price Equalization occurs for countries A and B if the value of their state dependent marginal products lie in the space spanned by the returns of internationally traded securities.

  Proof  Let sk = (sk (l), . . ., sk (α), . . ., sk (S)) ∊ Rs be the return to a traded security, Then pj (α)fn j = Σ k ajk sk and Pj (α)(fj – kj f’j ) = Σ k bjk sk , j = 1, for some coefficients ajk (k1 ), bjk (k2 ) by hypothesis of spanning.

  If follows that

  and system (4.10) is identical for all trading countries producing goods 1 and 2. Condition (a) or (b) implies the system is globally univalent, hence k1 ,k2 are equal across countries. Since marginal products depend only on k1 k2 lemma 4.1 gives the result.

  COROLLARY 4.3 (Factor Price Equalization) Assume international trade in securities and condition (a) or (b) holds for each trading country. If markets are complete or production uncertainty is multiplicative, then Factor Price Equalization occurs.

  Proof Both results follow from Proposition 4.3 . In the former case markets are complete so marginal products must lie in the space spanned by traded securities. In the latter case, fj (kj , α) = ϕ (α)hj (kj ), h’j > 0, h”j < 0 for some multiplicative factor, ϕ j (α), implies that f’i = ϕ (a)hj (kj )(h’/hj = (h’J /hj )fj is spanned by itself.

  Notice that Proposition 4.3 does not assert that Factor Price Equalization will generally occur (in fact it generally will not) but only gives conditions under which it will occur. Helpman and Razin [1978] argue, for example, that international trade in securities is the crucial element needed to cause equalization of the factor prices. Proposition 4.3 suggests instead that the important element is not international trade in securities but rather the size of the span of traded security returns relative to the state-dependent factor marginal products. It is possible to have international trade in securities and not have Factor Price Equalization even when condition (a) or (b) for global univalence holds. The reason is that prices βj (α) may differ from country to country even with international trade in securities. Different prices imply a different system (4.10) for each country and hence different factor prices. Only if marginal products happen to lie in the space spanned by returns of internationally traded securities is system (4.10) guaranteed to be the same across countries. In that case, univalence gives the result. To summarize, under uncertainty there are two conditions which must be met for global Factor Price Equalization instead of one condition under certainty. The system (4.10) must be globally univalent (also required under certainty) and the value of the marginal product must be spanned by the return of traded securities (automatically satisfied under certainty) in order for (4.10) to be the same set of equations across countries. Otherwise, cross-country differences in risk prices β j (α) cause (4.10) to represent different equations across countries. Univalence of different (4.10)

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  Contemporary and Emerging Issues in Trade Theory and Policy

  • Hamid Beladi, Kwan Choi, Sugata Marjit, Eden S. H. Yu, Hamid Beladi, Kwan Choi, Sugata Marjit, Eden S. H. Yu(Authors)
  • 2008(Publication Date)
  • Elsevier Science Ltd

    (Publisher)

  The wage-rental ratios of two trading countries are convergent if goods farther apart are poorer substitutes than goods closer together in the factor-intensity ranking. This generalizes the result in the literature, which is usually obtained under the assumption of Cobb–Douglas utility and production functions. Keywords: Factor Price Equalization, comparative statics, factor-intensity ranking, infinite-good model JEL classification: F11 1. Introduction Factor Price Equalization (FPE) has been used as a simplifying assumption in many theoretical and empirical models. Although FPE may not be a good approximation to the real world economy, it is often assumed for convenience. Increasingly, the restrictiveness of the FPE assumption is noticed in both empirical and theoretical works. Once the FPE assumption is dropped, changes in specialization pattern have to be taken into account and the results in comparative statics analyses may not be the same. For example, Jones (2002) stressed that how technical progress affects factor prices crucially depends on whether the production pattern of a country is altered. In this chapter, I will examine a comparative static problem Frontiers of Economics and Globalization r 2008 by Emerald Group Publishing Ltd. Volume 4 ISSN: 1574-8715 All rights reserved DOI: 10.1016/S1574-8715(08)04008-6 in a full-fledged general equilibrium model without assuming FPE. In particular, would international trade bring the factor prices of the trading countries closer to each other? Some earlier discussions like Ohlin (1952, Chapter 2) argued that international trade would only partially equalize factor prices between trading countries even if all countries use the same production techniques. Not much work has been done to examine the conditions for partial FPE. Pearce (1970, Chapter 16) , Uzawa (1959) , Deardorff (1986) and Falvey (1999) are exceptions.

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  Palgrave Handbook of International Trade

  • David Greenaway, R. Falvey, U. Kreickemeier, Daniel Bernhofen, David Greenaway, R. Falvey, U. Kreickemeier, Daniel Bernhofen(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  Samuelson, Paul (1948) ‘International trade and the equalisation of factor prices’, Economic Journal, 58: 163–84. —— (1949) ‘International factor-price equalisation once again’, Economic Journal, 59: 181– 97. —— (1952–53) ‘Prices of factors and goods in general equilibrium’, Review of Economic Studies, vol. 21, 1–20. —— (1956) ‘Social indifference curves’, Quarterly Journal of Economics, 70 (1): 1–22. —— (1962) ‘The gain from international trade once again’, Economic Journal, 72: 820–29. —— (1971) ‘Ohlin was right’, Swedish Journal of Economics, 73, 365–84. Stolper, Wolfgang, and Paul A. Samuelson (1941) ‘Protection and Real Wages’, Review of Economic Studies, 9, 58–73. Taussig, Frank W. (1927) International Trade. New York: Macmillan. Torrens, Robert (1815) Essay on the External Corn Trade. London: J. Hatchard. Vanek, Jaroslav (1968) ‘The Factor Proportions Theory: The N-factor case’, Kyklos, 21 (4): 749–56. Viner, Jacob (1937) Studies in the Theory of International Trade. New York: Harper and Brothers. Williams, John H. (1929) ‘The theory of international trade reconsidered’, Economic Journal, 39: 195–209. 3 General Equilibrium Trade Theory ∗ Alan Woodland † 1 Introduction Since the inception of the study of international trade, the most common modeling framework has been that of perfect competition and of general equi- librium. While the recent development of what has been called the ‘new trade theory’ has led to the analysis of trade issues in models involving imperfect com- petition, including monopolistic competition and oligopolistic competition, the perfectly competitive equilibrium framework continues to be a dominant force in international trade theory. The purpose of this chapter is to outline the main features of the perfectly competitive equilibrium framework as it has been applied in international trade.

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  The International Economy

  • Peter B. Kenen(Author)
  • 2000(Publication Date)
  • Cambridge University Press

    (Publisher)

  The factor-price-equalization theorem is a strong result, and it depends on strong as-sumptions. This is a useful point at which to recapitulate. All markets must be perfectly competitive. Both countries must have access to the same technologies and must produce both goods. There can be no trade barriers or transport costs. Returns to scale must be constant, and industries must differ in their factor intensities. These assumptions are unre-alistic. They serve nonetheless to highlight an important implication of the Heckscher–Ohlin model: free trade tends to maximize world output. Return to the pretrade situation in Figure 6-6. When the relative price of labor is OW 1 in Manymen and OW 2 in Fewmen, both industries are more capital-intensive in Fewmen. Therefore, the marginal product of labor is lower in Manymen, and the marginal product of capital is lower in Fewmen. Suppose that we could transfer factors of production from one country to the other. We could increase world output by moving labor from Manymen to Fewmen. Output would fall in Manymen but rise by more in Fewmen, because the marginal product of labor is higher in Fewmen. Similarly, we could increase world output by moving capital from Fewmen to Manymen. These transfers, however, would alter marginal products. The marginal product of labor would rise in Manymen and fall in Fewmen; the marginal product of capital would fall in Manymen and rise in Fewmen. After the gaps were closed completely, we could not increase world output by moving more factors around. World output would be maximized. Consider the role of trade from this same standpoint. Under the strong assumptions of the Heckscher–Ohlin model, free trade will equalize marginal products. The marginal product of labor will rise in Manymen and fall in Fewmen, closing the gap between marginal products without any transfer of labor. The marginal product of capital will fall in Fewmen and rise in Manymen without any transfer of capital.

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  General Equilibrium Analysis

  A Micro-Economic Text

  • Harry G. Johnson(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  Y , implying in the two-factor model that labour is an abundant factor at that point, exporting labour and importing capital can be conceptualized as negative production of the capital-intensive good and increased positive production of the labour-intensive good past the point of complete specialization, since according to the Stolper-Samuelson relation this change in outputs creates an excess supply of capital and excess demand for labour at constant factor prices. The consequent fall in the absolute (and relative) price and marginal product of capital and rise in the absolute (and relative) price and marginal product of labour implies that factor movement will provide factor-price equalization.

  FIGURE 2.8

  The factor owner production block approach to the theory of income distribution is illustrated in Figure 2.8 , a further variant of the Lerner-Pearce diagram. The production function of each good again is represented by a single isoquant, and XX and YY going through the factor endowment point E represent the maximum amounts of X and F that the economy is capable of producing with its given technology and factor endowment. Points I and I represent the endowment points of each factor owner which by the principles of vector addition must add up to E if it is assumed that all factors are fully employed. Complete specialization on X implied factor prices equal to the slope of the X -isoquant at point E and the factor utilization ratio OR in X , to which there is a corresponding point of equal slope on the F-isoquant indicating the implicit factor utilization ratio in F when production of F is zero, and given in the diagram as

  ORyo

  . Similarly, complete product specialization on good F implies a factor price ratio equal to the slope of the Y -isoquant at E and the factor utilization ratio OR in F, to which there is a corresponding point of equal slope on the X -isoquant indicating the implicit factor utilization ratio in X when production of X is zero, and represented in the diagram as

  ORXO

  .

  Given the optimal factor utilization ratios in the two industries when production is specialized, it is possible to determine the allocation of the resources of each factor owner between the two commodities on the dual assumptions of domestic factor mobility and that the factor quantities used in the two industries by each individual add up to his total factor endowment. These allocations are determined on the principles of vector addition by completing the parallelogram formed by the endowment point of each factor owner and the optimal factor utilization ratios in the two industries, in the separate cases of complete specialization on each commodity. When there is complete specialization on good X , OR and

  ORyo

  are the relevant factor utilization ratios, in which case owner I ’s factor allocations are shown by

  Ix

  , and

  Iy

  , indicating positive production of X and negative production of Y , while II ’s factor allocations are shown by

  IIX

  and

  IIy

  , indicating positive production of both goods, II ’s positive production of Y must, of course, offset I ’s negative production of this good if the economy is completely specialized on X . OR and

  ORxo

  are the relevant factor utilization ratios where there is complete specialization on good Y , in which case I ’s factor allocations are given by

  Ix

  ′ and

  Iy

  ′ indicating positive production of both goods, while TV’s factor allocations are shown by

  IIX

  ′ and

  IIy

  ′ indicating positive production of Y and negative production of X

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  Topics in Empirical International Economics

  A Festschrift in Honor of Robert E. Lipsey

  • Magnus Blomstrom, Linda S. Goldberg, Magnus Blomstrom, Linda S. Goldberg(Authors)
  • 2009(Publication Date)
  • University of Chicago Press

    (Publisher)

  It is assumed that E lies within the parallelogram O A QO B1 Q , so that factor price equal-ization between the two countries is achieved. Inferring Relative Factor Price Changes from Quantitative Data 49 Fig. 2.1 Relationship between net factor content of trade and relative factor prices ied in these imports. Thus, net exports of more educated labor are EN , while net imports of less educated labor are NC . Since the value of exports ( the quantity of more educated labor embodied in exports the wages of more educated labor the quantity of less educated labor embodied in exports the wages of less educated labor) equals the value of imports (the quantity of more educated labor embodied in imports the wages of more educated labor the quantity of less educated labor embodied in imports the wages of less educated labor) in the absence of capital trans-fers, it follows that the ratio of the net exports of more educated labor to the net imports of less educated labor (the slope of the line JECJ ) equals the ratio of the wages of less educated labor to the wages of more edu-cated labor. 3 Next, consider the e ff ects of a change in factor endowments in the two countries. To take the simplest case, assume that A’s endowments remain unchanged but that the endowment of less educated labor in country B increases. This is depicted in figure 2.2, which is the same as figure 2.1 except that the point indicating the two countries’ total endowments of the two factors shifts from O B1 to O B2 . The point describing the distribution of the total endowments between the two countries, namely, E , remains unchanged, but the diagonal indicating points where the two factors are consumed in equal proportions shifts downward from O A O B1 to O A O B2 .

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  International Trade and Agriculture

  Theories and Practices

  • Won W. Koo, P. Lynn Kennedy(Authors)
  • 2008(Publication Date)
  • Wiley-Blackwell

    (Publisher)

  u - v u - - - - - Y Y - - 52 THE HECKSCHER- OHLIN TH -p--- - _ - - In the previous section, we assumed that the price ratio in country A (P) is lower than that in country B (Pb), implying that the price of commodity Xis lower in coun- try A than in country B. Since commodity X is labor intensive relative to commod- ity Y, a labor-abundant country, such as country A, specializes in the production of commodity X and reduces its production of commodity Y, as shown in Figure 4.2. The production specialization of commodity X in country A increases demand for labor, causing wages to rise, and the demand for capital decreases. Since a capital- abundant country, such as country B, specializes in the production of commodity Y, a capital-intensive commodity, the exact opposite occurs, leading to an increase in the interest rate and a fall in wages. Thus, international trade reduces the pre-trade differences in wages and interest rates between the two countries and will eventu- ally equalize the prices of homogeneous factors. As long as relative commodity prices differ, trade between the two countries will continue. International trade expands until relative commodity prices are equalized. This implies that relative factor prices also become equal between the two countries. International trade also equalizes the absolute returns to homogeneous factors, under the assumptions discussed in the pre- vious section. Equalization of factor prices between two countries through international trade results in redistribution of income in the countries. Opening trade will raise the real wage and reduce the real returns to capital in the labor-abundant country, because the country specializes in producing labor-intensive goods (commodity X) and demands more labor and less capital.

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  International Economics

  Global Markets and International Competition

  • Henry Thompson(Author)
  • 2000(Publication Date)
  • WSPC

    (Publisher)

  This assumption is called ceteris paribus or other things equal. General equilibrium economics is the study of markets in an interconnected network. Other markets in the economy are allowed to adjust to changing prices and outputs in general equilibrium economics. The other things held constant in partial equilibrium economics can change enough to alter conclusions. For instance, the deadweight loss of a tariff is calculated in the partial equilibrium market for the imported product. In general equilibrium, the tariff distorts production along the production possibility frontier and consumption possibilities are reduced. The PPF and offer curves are tools of general 183 CHAPTER 6 Production and Trade 184 Chapter 6 Production and Trade equilibrium. The present chapter develops what goes on behind these summary curves. A critical issue is die income redistribution due to tariffs and other trade policies. Payments to some productive factors rise widi a tariff, while the payments to other factors fall. This chapter develops the tools to find out who wins and loses with a tariff. The specific factors model is a useful general equilibrium model. Each industry uses a type of capital specific to its production. Specific capital machinery and equipment is not used to produce outputs in other industries. Production of outputs shares labor input. The specific factors model can be viewed as a short run model, with specific capital not moving between sectors. Adjustment across the economy to tariffs, international migration, and investment can be uncovered in the market for shared labor. In the factor proportions model, two goods are produced by two factors. Both labor and capital are mobile between sectors in this long run model. The concepts of factor abundance and factor intensity lead to the four basic propositions of international trade theory. Issues of protection, migration, capi-tal flow, and income redistribution are analyzed with the factor proportions model.

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  The Pure Theory of International Trade and Distortions (Routledge Revivals)

  • Bharat Hazari(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  Part One THE THEORY OF FACTOR PRICE DIFFERENTIALS AND THE PURE THEORY OF INTERNATIONAL TRADE Passage contains an image

  2	FACTOR PRICE DIFFERENTIALS, THE SHAPE OF THE TRANSFORMATION LOCUS AND THE RELATIONSHIP BETWEEN PRICES AND OUTPUT LEVELS

  This part of the book (Chapters 2 –5 ) deals with some aspects of the theory of international trade under the assumption that the factor markets are imperfect. The factor market imperfection is assumed to take a specific form, namely that a qualitatively identical factor earns a higher reward in one sector of the economy compared with its reward in the other sector of the same economy.1 This type of factor price differential is regarded as distortionary and is distinguished from factor price differentials that need not be distortionary.2 For example, an observed wage differential between the rural and urban sector does not represent a genuine distortion if it is caused by, say, a utility preference between occupations on the part of the wage-earners. A factor price differential is considered to be distortionary when it cannot be explained on legitimate economic grounds. Various reasons may be advanced for the presence of a distortionary factor price differential. The reasons typically given in the literature are, for instance, differential factor taxation (Harberger (3)); or trade union intervention and the existence of the wage differential between the industrial and the subsistence sector of an underdeveloped economy.3 It is important to note that the distortionary factor price differential is assumed to exist in spite of the assumption of perfect factor mobility between sectors.

  In this chapter the standard model of trade presented earlier is extended to include the presence of a factor price differential. Since there are two factors of production in the model, capital (K) and labour (L), there are two markets in which factor price differentials can be introduced. However, to keep the exposition simple, we only introduce factor price differential in one market. We introduce an exogenous distortion in the labour market in which it is assumed that the qualitatively identical factor, labour, does not earn the same reward in both sectors of the economy. Given the presence of this exogenous distortion several issues are examined in this chapter, for instance, the relationship between commodity prices and factor prices, the impact of the distortion on the shape of the production possibility locus and the relation between changes in commodity prices and levels of output.

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