Factor price equalization theorem theory. Factor Price Equalisation Theory (With Obstacles) 2022-12-31

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The factor price equalization theorem is a theory in economics that suggests that, under certain conditions, the price of a particular factor of production (such as labor or capital) will tend to be equalized across different countries. This means that, for example, the wage rate for a particular type of labor will tend to be similar across countries, even if the cost of living or other economic conditions differ significantly.

The idea behind the factor price equalization theorem is that international trade can lead to a convergence of prices for factors of production. This occurs because, as countries trade with each other, they can specialize in the production of certain goods or services and import other goods or services that they do not produce. This specialization can lead to a more efficient allocation of resources, which can in turn lead to lower prices for the goods and services that are being traded.

One of the key assumptions underlying the factor price equalization theorem is that there are no barriers to international trade. This means that countries are able to freely exchange goods and services with each other, and that there are no tariffs, quotas, or other barriers that would limit the flow of trade. In addition, the theorem assumes that there are no significant differences in the productivity of the factors of production between countries. For example, if the productivity of labor is significantly higher in one country compared to another, this could lead to differences in wage rates between the two countries, despite the presence of international trade.

Another important assumption of the factor price equalization theorem is that there are no transport costs associated with international trade. In other words, it is assumed that it is just as easy and cost-effective to ship goods and services between countries as it is to produce them within a single country. This assumption allows for a more efficient allocation of resources and helps to ensure that prices are equalized across countries.

There are a number of factors that can impact the degree to which the factor price equalization theorem holds true in the real world. For example, if there are barriers to international trade or significant differences in productivity between countries, this could lead to differences in prices for factors of production. In addition, transport costs and other logistical issues can also impact the equalization of prices across countries.

Overall, the factor price equalization theorem is an important theory in economics that helps to explain how international trade can lead to the convergence of prices for factors of production. While there are a number of factors that can impact the degree to which this theorem holds true in the real world, it remains an important concept for understanding the impact of international trade on economic conditions around the world.

factor price equalization theorem (FPET)

factor price equalization theorem theory

The marginal productivity of a factor, like labor, in turn depends on the amount of labor being used as well as the amount of capital. Hence, a country is said to have comparative advantage when the latter produces good that requires those factor in which the nation is best endowed. Increasing returns to scale is possible with new technologies There is complete specialization Taste and preference are not identical Trade takes place in differentiated products instead of homogenous products Factors are mobile across nations Transportation costs do exist Full employment does not exist 6. If there is reversal of factor intensity, the factor price equalisation theorem will fail to hold. The relative factor price equalisation can be explained on the assumption that the value of marginal product MP of each factor within each country is equal before trade under the conditions of prefect competition in product and factor markets and constant return to scale. Since the two countries share the same marginal productivity relationships it follows that only one set of wage and rental rates can satisfy these relationships for a given set of output prices. The relative equalisation of factor prices can be explained also through Fig.


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Equalization of Factor Prices in International Trade

factor price equalization theorem theory

The difference in prices alone is sufficient to cause a deviation in wages and rents between countries, because it affects the marginal productivity. Thus, some of the assumptions made under the H-O model are relaxed as shown below: There exist more than two countries, commodities and factor endowments The level of technology is not the same across nations, for instance, the level of technology is further ahead in Japan to that found in African countries Read also Costs Of Production And Determinants Of Supply There is factor intensity reversal- for instance, although the level of technology remains the same across nations, a particular commodity may be referred to as labour intensive in one country and at the same time be capital intensive in another country. It is worthwhile to note that trade would achieve complete factor price equalization only when some conditions and assumptions are fulfilled. However, because the countries continue to have different quantities of factor endowments, they will produce different quantities of the two goods. On the other hand, suppose that the two commodities to be considered are X and Y and that the production of Y requires more capital-labour ratio than that of production X.

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Trade: Chapter 60

factor price equalization theorem theory

In the absence of transport costs or other impediments such as tariffs to trade, the most immediate effect of international trade is that it would equalise relative commodity prices in all regions. Thus, changes in prices of goods will trigger the distribution of the real income of labour and capital. When an innovative product is firstly introduced in the domestic market, reference is made to the new product stage. Over time, there has been ample controversy on the theory of international trade. It is assumed that the unit cost of producing X and Y commodities becomes equal in the two countries after the determination of trade equilibrium. As both countries specialise completely, the free trade commodity price ratio is α which lies outside the autarchy price ranges.


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What is factor price equalization and why is it politically important?

factor price equalization theorem theory

Similarities can be grouped in terms of a country's culture, taste and factor endowments. The vertical scale is longer than the horizontal scale. The theory is likely to become indeterminate in the multi-country, multi-commodity and multi-factor trade situation. These relative changes in K-L ratio will continue until the K-L ratios in both the countries become exactly equal. ADVERTISEMENTS: ii These countries produce two commodities, say X and Y. In this phase, production is likely to be low. In a perfectly competitive market, the return to a factor of production depends upon the value of its marginal productivity.

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Factor price equalization theorem (20TH CENTURY)

factor price equalization theorem theory

Y 0 and the factor-price line P 0P 0. Such a trend has been confirmed by economists like Kindelberger, Myrdal and Sodresten. If the economies of scale are present, according to Meade, the theory will become invalid for two reasons. The relative price of cloth in both the countries will tend to approximate to R 0E 0, when wage-interest ratio becomes equal at R 0. The writers like Samuleson 1948 and Lerner 1953 discussed the possibility of a complete equalisation of factor prices. The commodity price equalisation tendency is inherent, because the opening of free trade between two countries tends to eliminate the pre-trade differences in the comparative costs. The idea behind was to see whether capital abundant countries really export capital intensive goods and import labour intensive ones.

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5.14: Factor

factor price equalization theorem theory

Since the slope of factor price line P 1­P­ 1 at S is exactly equal to the slope of factor price line P 1P 1 at N these factor price lines are parallel , the factor price ratios have been equalized through trade. Over time, there has been ample controversy on the theory of international trade. If there is complete specialisation in one or both the countries, there cannot be equalisation of absolute or relative factor prices. Hence, its concentration on industries using much capital means greater relative scarcity of capital and less relatively scarcity of labour. The idea behind was to see whether capital abundant countries really export capital intensive goods and import labour intensive ones.


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Factor Price Equalisation Theory (With Obstacles)

factor price equalization theorem theory

Hence, according to H-O theory, factor abundance plays a key role for comparative difference in contrast to David Ricardo which advocates that labour is the sole responsible factor for international trade to be beneficial. It shows that after-trade equilibrium results in the equalisation of factor prices. In country A, originally the factor price ratio is represented by the slope of the factor price line P 0P 0 which is less steep. This implies that the level of technological progress is the same in the different countries. Ohlin, on the other hand, recognised that the international trade might result in only an incomplete or partial equalisation of prices of factors. . The relative factor price equalisation can be explained on the assumption that the value of marginal product MP of each factor within each country is equal before trade under the conditions of prefect competition in product and factor markets and constant return to scale.

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Factor

factor price equalization theorem theory

It is worth pointing out that for the Factor Price Equalization to hold, the previous assumptions made on the H-O should be present else the whole theorem would not stand good. Furthermore, findings suggest that Canada experienced a fall in its share of vertical intra industry trade while the opposite has been noticed in Mexico. When an innovative product is firstly introduced in the domestic market, reference is made to the new product stage. Factor-Price Equalization The fourth major theorem that arises out of the Heckscher-Ohlin model is called the factor-price equalization theorem. After trade, it becomes steeper as shown by the factor price line P 1P 1.

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Factor price equalization theory

factor price equalization theorem theory

Country A has comparative advantage in commodity X and B has comparative advantage in commodity Y. Likewise, region A which has plenty of capital but scarce labour, will import goods requiring much of labour and export goods embodying much of capital. Apparently, factor- price equalisation theorem is established at this point. Finally the value of productivity depends upon the output price commanded by the good in the market. The trade will lead to a rise in K-L ratio in country A and a fall in K-L ratio in country B. In the real world, the Factor Price Equalization might not be true to the whole extent. As there will be greater substitution of labour for capital, the price of labour will rise and that of capital will decline resulting in equalisation of factor prices.

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