Trade and Factor Prices. Factor Price Equalization. Trade and Input prices Stolper-Samuelson Theorem. As a result of trade in each country: The production of the good in which the country has a comparative advantage would increase
Factor Price Equalization
As a result of trade in each country:
A change in the price of a (traded) good results in a more than proportional change, in the same direction, in the price of the factor that is used in the production of that good more intensively; a labor-abundant country specializing (and exporting) the labor intensive good will see an increase in its wages proportionally more than the increase in the relative price of the labor intensive good.
under the H-O assumptions,
WA WB rA rB
A Simple Approach
PA = aA . WA
PB = aB . WB
If PA = PB ==> aA . WA =aB . WB
If aA = aB ==> WA =WB
By the same token:
If the labor in Country A is twice as productive as the labor in Country B, then:
2aA = aB WA = 2WB
In a Ricardian world where relative prices are determined by the (relative) labor content of each unit of a good, and trade is driven by relative price differentials (comparative advantage), after trade, the higher relative price of the good a country specializes in would result in higher (real) wages for all. Therefore, one would expect free trade to be supported by all.
In each country:
L = aLX . X + aLY . Y
K = aKX .X + aKY Y
Recall: aL = 1/MPL ; aK = 1/MPK
For any traded good:
Assuming fixed proportion production functions for both goods
(P)A = MC = aLXA . W + aKXA . r
(P)B = MC = aLXB . W + aKXB . r
Consider a country with capital and labor producing X and Y
where Px = Py = 2; Px/Py = 2/2 = 1
Px = w + r; (K/L)x = 1
Py = 0.5 w + 1.5 r ; (K/L)y = 3
Note that X is relatively more labor intensive
Where (Px/Py)A < (Px/Py)B ; WA < WB ; rA >rB
Note that Country A is labor-abundant
Good X is labor intensive
After trade: (Px/Py)A ; (Px/Py)B
MRTS = MPL/MPK= w/r
Note: assuming the basic assumptions of the H-O model hold, still complete output price equalization may not occur due to transportation costs, barriers to trade, and existence of goods that are rarely traded.
Yet, the factor price equalization theorem suggests an important policy alternative:Allow free trade in outputs, specialize in labor-intensive production, and export labor indirectly in the form of labor-intensive goods.
In recent years countries such as Ireland, the Philippines, India, Jamaica, and Bangladesh, China, and Malaysia have been doing just just that.
Wage = w = MPL . Price = Value of Marginal Product of Labor
(The demand for labor originates from this equation)
Capital rent = r = MPK . Price = Value of Marginal Product of Capital
(The demand for capital originates from this equation.)
An increase in the price (of a good) would make demand for the input
used in the production (of that good) increase (shift).
Assuming labor is mobile but capital is immobile,
wage rates rise in both industries, but by proportionally less than the price of shoes.
Country (say US) has a comparative disadvantage in
( labor-intensive) rug production and comparative
advantage in (capital-intensive) computer production. It
opens trade with another country.