Factor Price Equalization Theorem

International trade is definitely present since civilization. The need for trading exists because of the difference in availability of resources and comparative advantages. Nowadays, with globalization, it is impossible for a country to remain isolated and become self sufficient. Over time, there's been ample controversy on the idea of international trade. A few of these ideas will be discuss below.

2 Comparative Advantage Theory

The theory of comparative advantages, also known as the idea of comparative cost, originated by David Ricardo. Regarding to this theory, it matters not a bit whether a country has definite advantage in a single line of creation or all lines of development. What counts is the comparative difference and each country should focus on the production of these goods where it has the greatest comparative edge or least comparative drawback. Thus, for international trade and specialization to be profitable and beneficial, there's a need for comparative distinctions, that is, differences in comparative cost or dissimilarities in opportunity cost. Therefore, this theory compares the capacity of an country through its goods.

The theory of comparative gain relies on the following assumptions:

There are two countries and two commodities

There is ideal competition

Labour is really the only factor of creation which is homogenous and correctly mobile within the country but properly immobile across nations.

Cost of development is expressed in terms of labour, that is, a commodity is respected in terms of how much it costs a labour for producing it.

There is free trade, that is goods can move easily across nations

There is constant go back to scale

There is neither technical change nor travel cost

Trade takes place on barter system

There is full job in both countries

3 Heckscher-Ohlin Theory

Although comparative difference is the source for international trade, Heckscher- Ohlin (H-O) says that it's the conditions that bring relating to this comparative benefit that matter. In other words, how well a country is endowed with confirmed factor will impact its factor prices and ultimately its product prices. Hence, according to H-O theory, factor abundance plays a key role for comparative difference as opposed to David Ricardo which advocates that labour is the only real responsible factor for international trade to be beneficial.

The Heckscher-Ohlin view differs compared to that of the David Ricardo in the following ways:

There are two countries, two commodities and two factors of production

There is difference in the factor depth, that is, the proportion of every factor of development used differs.

Cost of creation is portrayed in terms of the money and not labour value

There is incomplete specialization, that is, both countries will wrap up producing both commodities

The H-O model has four main parts; the H-O trade theorem, Factor Price Equalization theorem, Stolper- Samuelson theorem and the Rybczynski theorem.

3. 1 Heckscher-Ohlin Theorem

According to the Heckscher-Ohlin trade theorem-also known as the factor proportions theory- a country shall export the item whose development requires the intensive use of the country's relatively numerous and cheap factor and shall import the item whose production requires the intense use of the country's relatively scarce and expensive factor. Hence, a country is said to have comparative advantages when the latter produces good that will require those element in which the region is best endowed.

It is to be noted that a country's factor endowment is denoted by the percentage of capital to labour. Suppose there are two nations- A and B- and capital-labour proportion is higher in region A than in land B. This might imply that nation A is capital numerous and region B is labour abundant. On the other hand, suppose that the two commodities to be considered are X and Y and that the creation of Y requires more capital-labour proportion than that of production X. This might mean that commodities Y is capital rigorous and X is labour-intensive. Therefore, nation A should focus on the creation of commodity Y and land B in the production of item X. These also entail that factor price- which is displayed as the price of capital to labour ratio - would be cheaper in land A than B.

Therefore, under the H-O trade theorem, region A shall export commodity Y and shall import commodity X and vice versa for region B for international trade to be profitable.

3. 2 Factor Price Equalization Theorem

Moreover, the H-O model predicts that international trade provides about equalization in the relative and absolute comes back to homogenous factors across countries. This is also called the Factor Price Equalization theorem. Assume nation B focuses on item X which is labour extensive and country A focuses primarily on product Y which is capital intense. The creation of good X in country B would increase and this of good Y would lower. Because of this, the relative demand for labour will increase and the relative demand for capital will show up. As a result, wages will climb and gain on capital will fall season in land B. The same holds true for land A whereby; the latter specializes in the production of good Y, thus increasing its production in accordance with good X. As a result wages in region A will show up and the come back on capital will go up.

Thus, it could be figured with specialization and trade, factor prices will tend to equalize. It is worth directing out that for the Factor Price Equalization to carry, the previous assumptions made on the H-O should be present else the whole theorem wouldn't normally stand good. However, even if a few of the assumptions are violated, it could be found that, with international trade, factor prices will have a tendency to equalize.

In the real world, the Factor Price Equalization might not be true to the complete extent. Evidence proved that developed countries which are seen as capital abundant have a high wages in accordance with developing nations that are labour- abundant. For instance, america has high wages and focuses primarily on the production of machinery and textile and China has low wages and specializes itself in the production of textile and clothes (Leamer 1995, p. 8).

3. 3 Stolper Samuelson Theorem

On the other hand, the Stolper Samuelson theorem shows that a rise in relative product prices has significant effect on the real income of factors used. Thus, changes in prices of goods will cause the distribution of the true income of labour and capital. For example, if the price tag on labour extensive good raises, this will not only lead to an increase in the real wage but will also curtail the real go back on capital. In addition, it is detected that there surely is a "magnification" effect, that is, a rise in the price tag on a given commodity will lead to a far more than proportionate change in the factor prices in a way that one factor price rises and the other decreases relative to the product price.

3. 4 Rybczynski Theorem

Contrary to the aforementioned, the Rybczynski theorem demonstrates the partnership between your change in factor endowment and the change in result. In other words, the Rybczynski theorem claims that as endowments in a single factor increases, the united states will produce more of that good which intensively uses that factor and produces relatively less of the other good.

4 Leontief Paradox

With time, the H-O model became to be observed as a vulnerable theory of international trade due to the unreality of many of its assumptions. There have been massive researches designed to examine the dependability of the H-O model. For example, in 1953, Wassily Leontief completed an analysis on the united states trade in 1947. The theory behind was to see whether capital numerous countries really export capital intensive goods and transfer labour rigorous ones. Results advised that contrary to what H-O model expected, the US that was the most capital numerous country in those days, was in simple fact importing capital intense goods and was exporting labour rigorous goods. This end result became to be known as the Leontief paradox.

However, the Leontief paradox was criticized at different levels. For example, in 1981, Stern and Maskus (1981) reveal the Leontief paradox and confirmed that the Leontief paradox was valid in 1958 but not in 1972. It had been found that in 1972, the US net exports required the intensive use of both physical and human being capital.

5 Product Life Cycle Theory

Several years later, in the middle 1960s, Raymond Vernon came forward with the Product Life Circuit Theory which declares a country's export will become import as a product undertake its life pattern. You will find three stages in the life span of a product; new product level, maturity product level and standardized product level.

When an progressive product is first of all launched in the local market, reference was created to the new product stage. In this period, production is likely to be low. Export of the merchandise is quite low at the end of this stage. With time, as the product became to be accepted, demand for this enhances both in the domestic and foreign market segments. This entail firm to create manufacturing facilities overseas to be able to expand their creation capacity to meet up with the rising demand of both local as well as overseas consumers. Subsequently, productions learn to happen in growing countries near to the end of the maturity level. Inside the standardized stage, the market for the product stabilizes. Therefore, manufacturers create in growing countries whereby the cost of development is relatively low. As a result, the product is now being brought in in the country where it was initially invented.

This theory assumes that the transmission process of a new technology occurs slowly but surely enough to generate temporary differences between countries in their access and use of new technologies. However, in the later 1970's, it was found that competitors could actually imitate product at a much higher speeds than previously envisioned. Moreover, Multinational corporations were able to start products in several market at the same time.

6 New Trade Theory

So way, the H-O model shows that the foundation for trade lies in the difference in factor endowments instead of the Ricardian model which depends on the difference in factor output. Yet, it could be noticed that in the current environment, developing global structure of trade bring new ideas of trade to the top.

Thus, a few of the assumptions made under the H-O model are laid back as shown below:

There exist more than two countries, commodities and factor endowments

The degree of technology is not the same across countries, for instance, the level of technology is further forward in Japan compared to that within African countries

There is factor strength reversal- for example, although the level of technology remains the same across countries, a particular item may be known as labour intensive in one country and at exactly the same time be capital extensive internationally.

Increasing dividends to scale is possible with new technologies

There is complete specialization

Taste and choice are not identical

Trade occurs in differentiated products rather than homogenous products

Factors are mobile across nations

Transportation costs do exist

Full employment will not exist

6. 1 Intra Industry Trade Theory

Taking the above assumptions under consideration, new trade ideas have been produced among which you have the Intra-Industry Trade (IIT) theory. The actual fact that the truth is there exists imperfect competition which is as a result of the wide range of products that are desired on the marketplace and economies of level at stable level, gives rise to IIT. IIT refers to operate occurring within the same industry or sector. Firms are often faced with competition anticipated to importation of the same products that are being made locally in their local country. Hence, these local firms are motivated to decide for export of these products in other areas/countries.

It can be observed that the bigger the similarities between countries, the higher the IIT tend to be. Similarities can be grouped in conditions of the country's culture, flavour and factor endowments.

There are two types of IIT; the horizontal and vertical IIT. The horizontal IIT requires trading in products of almost the same quality while the Vertical IIT consists of trading in goods of different quality and amount of product standardization. It could be noted that through the period 1990-2007, there has been a rise in vertical IIT between the US and NAFTA. Furthermore, findings suggest that Canada experienced a fall season in its show of vertical intra industry trade as the opposite has been seen in Mexico. Furthermore, it has been observed that 50 % of the sectors were dominated by poor vertical IIT for both the US- Canada trade and US-Mexico trade (Ekanayake et al 2009). The IIT theory can, however, be criticized about how we define an industry.

7 Porter's Diamond

In comparison to the H-O model, Michael Pastor (1990 cited Offer 1991) has emphasized four major drivers of competitiveness which are as follows:-

Firm Strategy Composition and Rivalry- competition between local firms, creation of the best possible business environment in which businesses can be create, survive and thrive, probably relying on cooperation around competition

Factor conditions - factors are not simply inherited but enhanced and developed as time passes(e. g. professional labour with specific skills)

Demand conditions- strong and sophisticated home demand which means that local companies are progressive and respond quickly to changes in tastes

Related and promoting business- ready access to supply chain establishments and closeness of related sectors.

According to Porter, a region attains competitive advantage if its businesses are competitive. Therefore, these factors above play an important role in acquiring competitive benefit.

8 Conclusion

In conclusion, it could be said that the theory of comparative advantages, indeed, forms the foundation of international trade. Over time, several models have been developed to describe the factors which results in comparative benefit. However, as described above, all models have certain limitations. Actually, each economy is different and is likely to adopt the best suited model to its framework.

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