International Economics >> Factor-Price Equalization Theorem and Income Distribution
Factor-Price Equalization Theorem and Income Distribution
With the passage of time, however, other economists have contributed a good deal to the theory of trade with Heckscher-Ohlin theory as focal point of reference. The later contributions may be classified as follows:
(i) Extension of Heckscher-Ohlin theory to other dimensions of trade, and
(ii) Alternative and complementary theories of trade.
2. FACTOR-PRICE EQUALIZATION THEOREM
The factor-price equalization theorem can be stated as follows:
Free international trade brings about equalization in the absolute and relative returns to the homogeneous factors of production and in their prices. Or alternatively, free international trade equalizes the wages of homogeneous labour and rentals of homogeneous capital across the nations.
In order to explain the factor-price equalization theorem, let us first define the homogeneity of labour and capital. Labour is regarded to be homogeneous when all the labour used in an industry has the same level- of education, training, skill and productivity. Capital is regarded to be homogeneous when the entire capital used in an industry has the same cost and productivity. The factor-price equalization theorem suggests that international trade makes the wages of homogeneous labour and returns on homogeneous capital and capital rentals to be equal in all the trading, nations.
The factor-prices equalization theorem is a natural corollary of the Heckscher Ohlin theory. In fact, Heckscher' had himself stated that free trade brings about equalization in the factor prices. However, Ohlin) argued that there is only a tendency toward the factor-prices equalization: there is no complete equalization. That there was only a tendency .toward factor-price equalization was .rigorously shown by Stolper and Samuelson", Later, however, Samuelson', one of the proponents of Stolper-Samuelson theorem, established that there was complete equalization of factor prices.
We turn now to discuss the factor-price equalization theorem in detail. The factor-price equalization theorem was developed in the framework of the Heckscher Ohlin model. Let us therefore recall here the basic assumptions of the Heckscher Ohlin theory as follows:
(i) There are two countries (A and B), two commodities (X and Y) and two factors (L and K);.
(ii) Country A is capital-abundant and country B is labour-abundant;
(iii) Factors of production are homogeneous, i.e., MP of Land K is same in country A and B;
(iv) Production functions of X and Yare different but they are identical in countries A and B;
(v) Production functions are homogerieous of degree 1 implying constant returns to scale;
(vi) Factors have inter-industry mobility within a country but they lack international mobility; and
(vii) Consumers in country A and B have identical taste and preference. In addition, in this chapter, we reverse our assumption regarding factor intensity of commodities X and Y simply for graphical convenience. In chapter 6, we had assumed commodity X to be capital-intensive and commodity Y to be labour-intensive. Here we assume that commodity Y is capital-intensive and commodity X is labour-intensive.
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