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/ THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION THEOREM by STEPHEN P. MAGEE, B. A. A THESIS IN ECONOMICS Submitted to the Graduate Faculty of Texas Technological College in Partial Fulfillment of the Requirements for the Degree of MASTER OF ARTS Approved Accepted August,

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Page 1: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

/

THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION THEOREM

by

STEPHEN P. MAGEE, B. A.

A THESIS

IN

ECONOMICS

Submitted to the Graduate Faculty of Texas Technological College in Partial Fulfillment of

the Requirements for the Degree of

MASTER OF ARTS

Approved

Accepted

August,

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:0! 6

SOS-

No. loo

ACKNOWLEDGMENTS

I am indebted to Professor Robert L. Rouse for his direction of

this thesis, and to Professors Paul A. Samuelson and Charles P. Kindle-

berger for their helpful criticism.

I also wish to acknowledge my great debt to the man who

introduced me to mathematical economics. Professor Jarvis Witt.

ii

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TABLE OF CONTENTS

Chapter Page

I. INTRODUCTION 1

II. HISTORICAL ANTECEDENTS 3

III. THE PROOF 8

IV. THE ASSUMPTIONS OF THE THEOREM 15

V. CONCLUSION 48

BIBLIOGRAPHY 50

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CHAPTER I

INTRODUCTION

One of the popular controversies in international trade theory

and indeed in international economic policy is the effect of free trade

on the return to productive factors. It was argued not many years ago

that reducing U. S. tariffs, for example, would precipitate an inundation

of Japanese goods produced by cheap labor, thereby driving down wages

accruing to American labor. This popular controversy has its counter­

part in th« theoretical literature as well. Samuelson's (1948 and 1949)

factor price equalization theorem was the first rigorous proof that trade

in goods alone(no factor movements) is sufficient to equalize the

returns to factors in two trading countries. There are eight conditions

which must be met, however, before price equalization can occur. The

purpose of this work is to examine these eight assumptions in the two

country, two good, two factor model. Are all of them necessary conditions

for the Samuelson proof? Are there modifications and relaxations of

these assumptions which would still permit the theorem to hold? One

purpose of the work here undertaken would seem to be to illustrate the

interplay between the very building blocks of international trade theory:

four inputs, four marginal productivities, two outputs, commodity price,

input prices and factor proportions for each country.

Originality is generally preempted by reviews of the theoretical

literature. My attempt to eliminate the assumption of zero transport

costs by input-output methods did not result in the theoretical

break-through that I had originally envisioned. Professor Samuelson

pointed out that in so far as transport costs pose no more an impedirr.ent

Page 5: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

to intra-country than inter-country unit product costs, the theoretical

substance of the paradox posed disappears. The impact of the transport

cost assumption is thus on possible verification of the theorem. To

eliminate the assumption even by incorporation via input-output methods

would limit, although not eliminate, the geographical impact of factor

price equalization.

One curiosum of international trade theory is why a complete

proof of the factor price equalization theorem was not forthcoming

earlier. The question had been discussed for over 150 years, and yet

only in 1948 did all the discussion bear real fruit. This historiccil

aspect will be discussed in Chapter II. Chapter III will be a short

description of Samuelson's proof of the theorem. Chapter IV will be

an examination of the eight assumptions and the questions posed above,

while Chapter V will be a summary.

Page 6: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

CHAPTER II

HISTORICAL ANTECEDENTS

The proposition thettnobility of factors between international

trading entities would equalize factor prices has never been open to

real question. For example, mass migrations of Japanese laborers to

the United States and American capital to Japan would equalize absolute

wage-rent levels in the two countries.

One economic motivation of the National Origins Act of 1924

limiting immigration to the United States was a recognition of this

obvious fact. But even when factors flows are severely if not com­

pletely limited, there was the feeling in nineteenth century literature^

that goods flows might tend to equalize factor prices. This thought J

is even more important in light of the assumption that factors are

immobile internationally.

Caves (1960, p. 24) points out that this analytical problen-.

is grounded in the Ricardian comparative costs framework. Ricardo

(1821, pp. 77-79) argued that trade was justified in a two good, two

country context even if one of the countries possessed an absolute

advantage in the production of both goods. The advantage to both

supposedly lay in the specialization of production. Sar.uelson (1958)

has illustrated this principle in his example of an econoir.y containing

a lawyer and a typist. The lawyer has an absolute advantage in his

practice of the law but also happens to be a better typist than the

professional. In this case, even though one is absolutely superior in

both endeavors, it makes eminently good sense to follow Ricardo's

admonition, letting the lawyer practice law and the typist type (not

to mention the employment effect).

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J

Ricardo*8 labor cost theory of vaikue was an inappropriate base

for his theory of comparative costs. But if we give his theory the

charitable two factor interpretation, then we are prepared to explain

differences in comparative costs between two countries. Heckscher '"1

(1919, pp. 497-512) showed that if two countries have the same factor

endowments and use the same technique in all branches of production,

then comparative costs (i. e. comparative advantages) are the same.

In this case there could be no gain or loss from trade. Heckscher

derived two necessary conditions for differences in comparative costs

between countries:

1. Differences in factor endowments

2iffDx€fecendBS in factor intensities in the production of different goods (if they were the same, then price ratios would be the same in the two countries).

He then stated that such differences would cause trade to "expand until

an equalization of the relative scarcity of the factors of production

among countries has occurred." (Heckscher, 1919, pp. 285-286) Thus,

Heckscher (1919) was the first in the history of the factor price

equalization controversy to formulate systematically a statement that

equalization could, in fact, occur. He proposed a proof based on the

notion that factor price equalization could occur only when the input

coefficients were fixed for each good and were identical between coun­

tries. But in a fixed coefficient model, relative factor prices cannot

vary continuously with relative commodity prices (even with perfectly

competitive factor markets). This logical flaw invalidates the Heckscher

proof, particularly when one notes that fixed factor supplies and

fixed input coefficients often imply that one factor is fully

employed in each country. This is the linear programming model of

contemporary economic theory with two constraints. Factor price

equalization can occur then only if both countries produce the same

good; but this violates the principle of comparative advantage. Caves

(1960, p. 81) gives a more favorable reading to the Heckscher proof

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than the one above; he acknowledges its path-breaking nature and

intuitive grasp of the mechanism of international trade.

Heckscher's student, Bertil Ohlin (1933), approached inter­

national trade from the Casselian general equilibrium viewpoint.

His important contribution to the Heckscher model was its incorpor­

ation of demand. He encountered some difficulty as Caves (1960, p. 28)

points out, in "verbalizing his general equilibrium system," which

caused the Heckscher-Ohlin theorem to ignore demand in a rather )

important way. The Heckscher-Ohlin theorem, for many years one of the

most important in international trade theory, states that countries f

tend to export commodities requiring more of their relatively j

plentiful factors.

The singular absence of any reference to demand in the theorem

seems to be atavistically classical, although not without reason.

Demand considerations have always been troublesome in international

trade theory as evidenced by Ohlin's (1933, p. 38) feeling that I

"complete regional price equalization was impossible" because demand | ^ "*

for factors was localized and joint. >

The looseness of the Heckscher-Ohlin theorem has been tightened

by Caves (1960, p. 28) who shows that a "country tends certainly to

produce those commodities which require more of its relatively plentirul

factors; whether it exports these depends on the preferences of domestic

consumers for these relative to other goods." The Hecks_cher-Ohlin

theoripm would easily hold if we merely adde^_the assumption that there_

is little variation in demand relative to productive capabilit^ies between

country es_.

The relation between factor returns and free trade has a long

history in international economic theory. Bastable (1903), Cairns (187-^),

Taussig (1927), and Ellsworth (1938), have dealt extensively with the

subject. For our purposes, the most relevant work was a paper by Stolper

oy

Page 9: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

and Samuelson (1941). Their theorem was a logical extension of the /^*^

Heckscher-Ohlin theorem: it asserts that reducing tariffs will expand"! ^ ^ ^

trade, raising the marginal product (and distributive share) of the 7 /

abundant factor while reducing the marginal product (and distributive

share) of the scarce factor in each country. The assumptionsylneedad -'

for the proof are restrictive but the proof is free of the index

number problem. In practical terms, it says that elimination of

tariffs, say, between the United States and Japan will benefit American

owners of capital and Japanese laborers. Japanese capitalists and

American laborers, conversely, would lose. These results are dependent

on at least six necessary conditions:

1. Identical linear homogeneous production functions for each good in both countries.

2. Costs of production being independent of the scale of production.

3. Perfectly inelastic supply functions for the productive factors.

4. No cessation of production of imported goods at home.

5. The U. S. has a comparative advantage in the good utilizing relatively more capital than labor.

6. Perfect competition.

'Consider the United States before trade: it produces watches and

wheat with labor and capital. Watch production is relatively labor

intensive and thus wheat production is relatively capital intensive.

If the United States has a comparative advantage in wheat production,

then the movement from autarky to free trade would be accompanied by

U. S. exports of wheat. Caves (1960, pp. 68-69) verbalizes the proof

that Stolper and Samuelson (1941) give at this point:

As the wheat industry expands, it will bid factors of production away from the(import-competing) watch industry. But the latter will release relatively much labor and little capital, compared to the propor­tions in which the expanding industry demands these

Page 10: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

two factors. Therefore, there will be substitution in both industries toward the use of relatively more labor and relatively less capital. The marginal productivity of labor, which is the same in both Industries because of the assumption of perfect factor markets, will decline in both industries; that of labor will rise. With the reward to each factor equal to its marginal value produc­tivity, the real return to capital will rise (whether we measure it In wheat or watches), and the real wage of labor will fall.

The theoretical groundwork is now complete for an examination of

the factor price equalization theorem.

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CHAPTER III

THE PROOF

Before proceeding with the mechanics of the system, it will be

helpful to set forth the eight hypotheses Professor Samuelson (1949,

pp. 181-182) used in his proof.

1. There are but two countries, America and Europe.

2. They produce but two commodities, food and clothing.

3. Each commodity is produced with two factors of production, land and labor. The production functions of each commodity show "constant returns to scale," in the sense that changing all inputs in the same proportion changes output in that sMme proportion, leaving all "productivities essentially unchanged. In short, all production functions are mathematically "homogeneous of the first order" and subject to Euler's theorem^

ri

4. The law of diminishing marginal productivity holds: as any one input is increased relative to other inputs, its marginal productivity diminishes.

5. The commodities differ in their "labor and land intensities." Thus, food is relatively "land using" or "land-intensive," while clothing is relatively "labor-intensive." This means that whatever the prevailing ratio- of wages to rents, the optimal proportion of labor to land is greater in clothing than in food.

6. Land and labor are assumed to be qualitatively identical inputs in the two countries and the technological production functions are assumed to be the same in the two countries.

7. All commodities move perfectly freely in international trade, without encountering tariffs or transport costs, and with competition effectively equalising the market price-ratio of food and clothing. No factors of production can move between the countries.

8. Something is being produced in both countries of both commodities with both factors of production. Each country may have moved in the direction of specialising on the

8

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commodity for which it has a comparative advantage, but it has not moved so far as to be specializing completely on one commodity.

To be complete, we should actually add a ninth which Professor

Samuelson (1949, p. 183) added in the body of his paper: "in each

country there is assumed to be given totals of labor and land." J / ,

When these conditions exist, then real factor prices will be the

same in both countries. (Cave^ (1960, pp. 77-78) has described the proof

of this statement as a three step process. First, the production

functions must yield a transformation curve concave to the origin.

Second, there must exist a unique relationship between price commodity

ratios, production levels and factor marginal productivities. Third,

international trade must equalize product prices in the two countries^

Thus, a single price ratio in the two countries implies equal

factor ratios in the production of each good. Linear homogeneity of

the identical production functions means equality of both the marginal

productivities and hence of factor prices.

Assumptions 3 and 4 bear directly on the shape of the transformation

curve between food and clothing. With constant returns to scale, halving

the two inputs used to produce food would halve the output of food. This

is shown in Figure 1 below. /If all land and labor were devoted to food

production, the economy would be at point B. But halving the inputs

would cut food production in half (0A»1/20B). Thus we know that at worst,

the transformation of food into clothing would follow the linear BCD

curve.'' The preceding argimient rules out a curve convex to the origin

(BGD). But it would be economically inefficient to produce goods with

identical factor proportions. This follows immediately from the hypo­

thesis that food is land intensive while clothing is labor intensive. Thus,

by transferring a bigger portion of labor than land to clothing production

we could do better than point C in Figure 1, say point F. We are insured

that the transformation curve is concave below at point F because

Page 13: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

10

of diminishing marginal productivity. As more and more labor is

transferred to clothing, its marginal product declines (assumption U).

CL0THIM6

FOC7P

Figure 1 - Three possible transformation functions between food

and clothing

The concave transformation function is important for the proof ^

because it helps preclude specialization in production. If both Europe/

and America had transformation curves of BCD variety, then America

would specialize in food production and Europe in clothing production

because of relative factor endowments. But the slopes of the trans­

formation curves in equilibrium would be unequal, implying inequality

of commodity prices. Thus, assumptions 3 and U are necessary ("but not

sufficient) to assure that assumption 8 holds. Assumption 7 (perfect

competition) insures us that ve are, in fact, on the transformation

curve rather than below it.

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|(;<t:|!

11

/ Thus, the concave transformation curve implies that as clothing

expands, the law of increasing marginal costs of clothing in terms of

food is invoked. But increased clothing production places pressure on

the price of the factor it uses most intensively, on wages relative to

rent, A higher wages-rent ratio is accompanied by a decrease in the

proportion of labor to land in both industries. An increase in the wages-

rent ratio pushes up the price of the labor-intensive commodity

(clothing) relative to the land-intensive commodity (food). We have now

come the full circle, illustrating the monotonic relationship between

commodity price ratios, production levels and factor price ratios.

Figure 2 shows the relation between commodity and factor price ratios.

Figure 2 - The left quadrant shows an inverse relationship between P-iP and w/r. The right quadrant relates optimal labor to land. ratios (L/T) for any given wage to rent ratio (w/r).

The higher the wage/rent ratio, the lower the price of food is relative to

clothing. Once demand specifies the prices and quantities of each rood.

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12

the v/r ratio is uniqueiy determined. At this value, there will be

optimal valuesodf L/T in both industries. Since clothing is relatively

labor intensive, (L/T) ia greater than (L/T)-,, Although Figure 2

illustrates only one country, the diagram for the other will be

identical since identical linear homogeneous production functions are

assumed (hypothesis 6), Trade equalizes P^/P in Europe and America.

These propositions can be illustrated mathematically as

follows (Samuelson, 19^9$ pp. 190-193).^ Food production, F, is a Joint

function of labor devoted to it, L-, and of land, T-, denoted

F=F(L^, T^)=T^f(L^/T^). (l)

The right portion of the equation is a direct result of using

production functions which are homogeneous of degree one (ass\anption 3).

The general case of a function homogeneous of degree p obeys the

following property: if both inputs are multiplied by k, then output

is multiplied by kP,

F=F(L^ T^j k^F=F(kL^, kT^).

In the first degree case, p = 1 so that doubling inputs, for example,

wou^d Just double outputs. This is essentially what we did in (l)

above. The argument was multiplied by 1/T and the function itself by

T producing no change in F. But it is a helpful formulation to

express food production as T (a scalar multiple equal to land devoted

to food production) times f(L /T^) the return to food on one unit of

land. Similarly, we can write clothing production, C, as a function

C = C(L^, T^) = T^c(L^/T^).

The marginal physical product of labor ia food is written

^^fL^ = f'(L^/T^) ,

which is simple partial differentiation of (l). Here f represents fr

^^^LF

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^•P

13

marginal product of labor on one unit of land and by our assumption

of diminishing returns (hypothesis 4)

f"(L^/T^) - ^ 0 .

The marginal product of land can be obtained by differentiating (1)

or by the use of Euler*s theorem (tceatlng the marginal product of

land as a rent residual),

^ T F - Q F / J T ^ - f(L^/Tp - L^/T^ i*(L^/T^) - g(L^/Tp .

We interpret g as the "rent residual" and its marginal product i^

g'(L^/T^) - -L^/T^f"(L^/Tp^ i/

Similar relations hold for clothing:

MPP^^- ^C/^L^-c»(L^/T^)

MPP g -4SIC/<9T^ - ^^^c ' c^ " W ' ^ ^ c ^ ^ c ^ " ^<^/^c^

h'(L /T ) - - L /T c"(L /T ) . c c ^ c c c c

By considering one country at a time, we know that factor returns

will be the same in food and clothing, regardless of the measure used.

This is expressed

Pf • ^LF ' c • ^LC ^-^^-

P^ . MPP,j,j, = P^ . MPP^^ ; i^^i

or in terms of our previous notation

This we can write implicitly

(P^/P^)f'(L^/Tp - c'(L^/T^) - 0

(P^/P^)[f(L^/Tp - L^/T^f'(L^/T^)] - [c(L^/T^) - L^/T^c'(L^/T^^^ „ Q.

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14

Our system is now reduced to two equations and the three

unknowns L./T-, L /T and P./P . But combining demand conditions I z c c f c

in the two coimtries gives two additional equations specifying

P^ and P . This leaves four equations and four unknowns, closing

the system. The proof is complete. /

Page 18: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

p;r

CHAPTER IV

THE ASSUMPTIONS OF THE THEOREM

This chapter is a piecemeal dissection of the hypotheses on

which the factor price equalization theorem rests. ' It is an exercise

to determine their several necessities and the extent to which they

can be modified, ceteris paribus, without violating the conclusion of

the theorem. As each is examined, the assumption is made that the

others contlnua to hold. Assumption 2 and the first part of

Assumption 3 are considered jointly for convenience. The hypotheses

follow the same order as the listing in Chapter III.

1. There are but two countries, America and Europe.

i

This assumption is not at all necessary since in the general

equilibriiim context of N countries we can merely add an equal number

of equations and unknowns to the two country case and return to equi­

librium as Caves (1960, p. 82) has shown. Tinbergen (1949), on the

other hand, points out that adding more countries simply increases

the likelihood of specialization, which, as we shall see below,

usually leads to an inequality of factor prices. This follows from

the observation that for any given set of production relationships

between two goods, there exists an upper bound on the deviation in

factor endowment ratios between the countries (given that no country

specializes). But the greater the number of countries involved, the

greater the likelihood of specialization. In Figure 3 factor prices

would be equalized in countries 1, 2, and 3, but the addition of

country 4 disrupts the relationship since it specializes in good X.

In general, however, the N country case does not logically invali­

date the theorem.

15

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16

COWiXr h •y+

Figure 3 - The four country model

Laursen (1952, p. 551) would possibly attribute to wide ranges of

population density the situation depicted in Figure 3.

2. They produce but two commodities, food and clothing.

3. Each commodity is produced with two factors of

production, land and labor.

These two assumptions will be considered together for convenience—

the second part of assumption 3, (3"), will be dealt with separately.

Caves (1960, p. 77) adds a further qualification to 3' which is implicit

in Samuelson*s presentation: the factors are given and fixed in quantity

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17

for each countrx*. Samuelson (1948, p. 174) also implies full

employment of the factors. Given N goods and M factors, we will

consider five cases.

Case a - The number of goods produced equals the number of factors utilized (N - M). Here N refers to goods and M to factors.

Laursen (1952, p. 548) points out that the essense of factor-

price equalization under free trade is a coupling of two systems: the

points of contact between these systems are uniform commodity prices

and identical production functions. So long as these "points of

contact" are maintained (i. e. commodity movements prevent differential

factor endowments from being reflected in differences in marginal

productivities), the generalized N - M case does not alter the

conclusions of the theorem.

McKenzie (1955) uses vector and activity analysis in the case

where N «» M = 3. If X and Y. are inputs and outputs respectively th ^ ® " ®

in the s activity vector (i * j = 1,2,3,goods), with w and p being

the respective factor and goods prices, then we can specify the zero

profit- condition, (inputs X. are negative).

S_v-y- + £w,x. - 0. (3)

We will deal with the unit activity level ( S Ix 1 = 1). Thus we can

define a set S of factor input vectors (X.) whose components sum to -1

This set is shown in the equilateral triangle in Figure 4a. Since the

altitude of the triangle is 1, the i component of X = (x^, x^, x^) is

the negative of the perpendicular distance from X to the side opposite

the i^^ vertex: (if X—1/3, -1/3, -1/3), we are at the center of

triangle 4b).

Page 21: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

'yrr'' *^

18

^ek 5 ^ unrf

"*Hij >€rj7\av\c

The vector space K (at left) is the pw

set of all price-wage vectors at which factor prices are equalized.

'^i.0r\>O)

7}-- (^.a-i)

(-l.0>0)

Figure 4b - The vector space denoting the components of a three tuple vector (perpendicular .distance to the respective side).

Page 22: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

19

Let R be a normalixed vector of factor supplies for the k^" country.

McKenzie then shows that for any given price-wage vector (p, w) we

can define a subset K of all elements of S which are linear com-pw

binations of the s's such that the zero profit condition (3) holds. 1 2 If the endowment ratios for the two countries (R and R ) lie inside

the subset K then factor prices are equalized at pw. At the same

price but a different wage, say pw*, we have a new subset K ,. These pw

two subsets do not overlap and are separated by the hyperplane H.

Thus, any given (p,w) is the factor price equalization vector

if and only if the factor endowments of the countries involved (2 or more) lie in the subset K .

pw

The general N good, M facaocrcase where N - M, has been con­

sidered by Samuelson (1953). His notation has been utilized heavily

in what follows. The N goods are denoted X., X., . . . , X^ and are produced by M factors of production V^, V^ V^. V^. stands

for the amount of the j*^^ input used by the i^^ industry. The production

functions for the N goods can be written

X. - xi(V.,, V,., . . . , V. ) (i - 1, 2, . . . , N). (4) 1 il» '12' • • • » 'im

The coefficients of production are denoted a^ » V^./X^ and are

inputs v.. per unit output of X^.

Perfect competition and intra-country factor mobility assures

that the value marginal productivity of each factor will equal its wage.

If commodity prices are p^, . . . , p , and factor prices w^, i 1 . , w^,

then equilibrium requires ^

„ ip Jxi(a,, \J^\i (i • 1. 2. • • • . « (5) (j - 1. 2 l)-

Page 23: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

20

or equivalently its dual

p. - a -w + . . . + a. w ' i il 1 im m

The latter formulation has the following linear programming inter­

pretation. If the cost of producing good X. exceeds its market value

^i il 1 ^12^2 + . . . + a. w ) in the optimal solution, then the

im m * '

good is not produced (X « 0). Equality of price and unit cost in the

dual implies that X. » 0.

The most general system would consider factor supplies a

function of all good and factor prices. For simplicity Professor

Samuelson has chosen to represent factor supplies as perfectly inelastic so hhat V . , . . . , V are constants, i ' m

^^ij " ^Ij^l •*• *2j^2 + • • • + a^jX^ ^Vj (j - 1, 2, . . . ,m).(6)

The equality in (6) denotes the fact that all non-free factors must be

fully employed. If w. becomes zero, the ^ replaces the • sign in the

j equation and the j factor is free.

Finally, we can aggregate total demands and supplies (in their

most general representation) and write them in the following functional

form:

X. - D"''(p,, . . . , p , WT , . . . ,w ) (i » 1, 2, . . . N). (7a) 1 1 n 1 m

X. = S^(p^, . . . , Pj ,w , . . .,w^) (j - 1, 2, . . . M).(7b)

But Walras's Law assures us that there are at most only N + M -1

independent equations since^p.Di ^£yj.S^ is the familiar earning-

expenditure identity of classical economics.

We are prepared now to count equations and unknowns to insure

the logical completeness of the system.

Page 24: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

21

UNKNOWNS

a*s

w's

P's

X»s

NM

M

N

N

EQUATIONS

(4) N

(5) NM

(6) M

(7a and6)N4M-l

NM+2M+2N NM+2M+2N-1

At first blush the system seems to be underdetermined since there is

one more unknown than there are independent equations. But it must

be remembered that (7a) and (7b) are homogeneous of degree zero: our

equations depend only on ratios of p*s and w*s so that equations and

unknowns are, in fact, equal. Samuelson (1953, p. 11) suggests that

we could also handle the problem by assigning a numeraire (p, • 1 or w. =

or making some "non-homogeneous monetary assumption" such as

5 P .X. " a constant MV. The effect of the latter operations is to

determine the absolute as opposed to the relative price level.

The method of counting equations and unknowns is inadequate in

considering the "existence" problem of general equilibrium. Dorfman,

Solow, and Samuelson (1958, pp. 346-389) have invoked the Kakutani

fixed point theorem as a rigorous final step in the proof that linear

programming solutions to general systems such as the one above do exist.

Case b - The number of goods produced exceeds the number of factors utilized (N > M).

Laursen (1952; ,p. 552) shows that factor prices are still

equalized and the probability of specialization is reduced as N grows

relative to M. Samuelson (1953, p. 7) analogously argues that we have

N-M degrees of freedom in the geographical production pattern for any

given world totals to be produced. The conclusions of Samuelson's

theorem are generally inapplicable, however, in the following case.

1)

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22

Case c - The number of factors exceeds the number of goods produced (N < M).

Vanek (1960, p. 634) and many others show that in general

factor prices will not be equalized when N<M, although it is possible,

He describes the geometrical situation required for factor price

equalization in the two good, three factor case (X and Y goods;

K, L'and T factors). Consider two boxes (two countries) in three

dimensions (Figure 5). 0 . and 0 ^ coincide while 0 . and 0 2* ^^^

respective origins in countries 1 and 2, do not.

^^unfrij 2.

Figure 5 - The three factor, two good model

The factor price equalization theorem holds only if both contract

curves (connecting 0^^ and 0^^ ^^^ °yl ^^ °y2 respectively) are in

one surface, passing through 0^^, 0^^, and 0^^ ^^ °y2 ''^^''^ ^^

generated by a family of lines, all passing through 0^^. It goes

without saying that this condition is generally not fulfilled

empirically.

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23

If Europe and America have different endowments of capital,

then the relative value of L and T in the area with the larger K is

enhanced relative to the other.

Case d - Input-output relationships exist between the goods produced

Vanek (1963) considers the case where there are two goods

(X and Y) and two factors (T and L) and where X is input in producing

Y and Y is an input in producing X. The input coefficients are fixed

(a^—X required per unit Y; a^—Y required per unit X). If a.-a^'O,

we have the usual case depicted at point E in country 1 in Figure 6a.

V

Figure 6a - Transformation curves for the two-good input-output case

&• A' ^4

O^

^ d<7uri4v-u 1

Figure 6b - The Edgeworth-Bowley representation of two-good input-output case

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24

In Figure 6b, one unit of X is denoted by the U isoquant and

the price of X is 0 A in terms of labor, while Y' price is 0 A* in

X s * y

terms of labor. Then we introduce input-output relationships; the

isoquants shift outward from the respective origins. Since a.^ is

larger, the relative decrease (largest isoquant shift) is the largest

in the Y good. Since relative prices are equalized in the new situation

(Ob/Ob* in country 1 equals 0 b/0 b* in country 2), then so are

factor prices (slope b'n* in country 1 equals slope of b'n' in country 2)

Thus, Samuelson*s conclusions are vitiated in the input-output case.

One way to eliminate the zero transport cost assxomption would be

to consider transportation a final good and treat it as an input in the

"production" of other internationally traded goods. We must assume,

however, that unit domestic shipping costs are no less than unit inter­

national shipping costs (not unrealistic since per mile costs are lower

for non-bulk ocean shipping). But this assumption would effectively

limit factor price equalization to "enclave" type production and

consumption items.

Case e - Supplies of productive factors are responsive to factor prices

In the case where factors are not in perfectly inelastic supply

with respect to factor prices, we can still have factor-price

equalization. The most general case can be seen in McKenzie's (1955)

diagram (4a): for different factor price vectors (p,w) we would simply

get factor endowment ratios which are more divergent for each country

than in the fixed factor case. So long as there existed some (pw) for

which the subset K contained the vectors R^ and R^, our conclusions pw

are unchanged.

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nwrnm-'^

25

I L

Figure 7 - Variable factor supplies: A and B are points in autarky; C and D are free trade points with fixed factors; E and F are possible equilibrium points when factors are variable

Notice, however, that the likelihood of complete specialization

is increased in the variable factor case because original factor endow­

ments tend to become even more divergent as the price of the abundant

factor increases with trade (Caves, 1960, p. 104). As country 1

produces more X in trade, P. rises and P^ falls, causing the T/L ratio

to fall (Figure 7). Thus, country 1 produces even more X for export

and country 2 even more Y. The factor prices remain equal although a

higher elasticity of the factor prices could easily have led to

specialization.

1 3. The production functions of each commodity show "constant returns to scale," in the sense that changing all inputs in the same proportion changes output in the same proportion, leaving all "productivities" essentially unchanged. In short, all production functions are mathematically "homogeneous of the first order" and subject to Euler's theorem.

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26

4. The law of diminishing marginal productivity holds: as any one input is increased relative to other inputs, its marginal productivity diminishes.

Samuelson (1949, pp. 184-185) uses assumption 4 to assure the

concavity from below of the production possibility curve. Constant or

increasing marginal productivity would allow specialization and non-

factor price equalization. Thus our main concern will be with

assumption 3". Laing (1961) has shown on the Lerner diagram that

increasing and decreasing returns to scale will prevent factor price

equalization. For example, he says that "if commodities have opposite

returns in each country and if each commodity has opposite sorts of

returns in the two countries," then only commodity prices can be

equalized (Laing, p. 343). He uses a portion of the Samuelson-Johnson

factor-price, commodity-price diagram to illustrate this result. In the

three cases in Figure 8, we have the CR line depicting constant returns

to scale while good Y is subject to decreasing returns in country 1

(to left of CR) and increasing returns in dountry 2 (to right of CR).

Although trade can never equalize factor prices, we can get an idea of

the direction of movement by looking at the situation before trade

occurs (X is L intensive and Y is T intensive).

In case 3"a, country 2 has the highest commodity price ratios and

factor price ratios prior to trade (B>A for both ratios). In this case,

the factor prices converge during the dynamic process but overshoot in

final equilibrium.

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27

3" OL

3U

3"c

Figure 8 - Three factor price-commodity price patterns

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28

In case 3"b, country 1 has the highest commodity price ratio

and factor price ratio prior to trade (A>B for both ratios). Here

factor prices converge but fall short of equality with trade.

In case 3"c, country 2 has a higher commodity price ratio and

lower factor price ratio. In this case, factor prices diverge with

trade.

In case 3"d, the export industries of both countries have

increasing returns. This is a subset of case 3"a above, where factor

prices first converge, but then diverge.

In In case 3"e, the export industries of both countries have

decreasing returns. This is a subset of case 3"b above, where factor

prices converge but fall short of equalization.

It is obvious that assumption 7 (perfect competition) is also

violated with increasing returns. The theorem clearly fails to hold in

these cases.

Minhas (1962) has attacked the production function problem in

ammore general way. He defines what is called a "homohypallagic

production function" of the form

V = [A T +a L ]-l/Bx (for good X; similarly for Y). « X X

V is the deflated or real value added in the X industry, T and L are

the two factors of production and A , B and a are parameters. The

elasticity of substitution J^= p~^ is assumed to be constant throughout,

He shows that the relative factor intensities of two industries X and Y

are independent of the factor prices only ifj*x -/v (this is a most

important conclusion in dealing with factor reversals). For the ful­

fillment of this condition, Minhas shows that "it is sufficient that

all industries be subject either to a Cobb-Douglas production function

where/j,» J"-i / or to a fixed coefficient production function where

J'^'zXf ^ 0 (pp. 142-143). ItS^t-Stf . then there will inevitably be

a reversal at some value of w/r. The diagrammatic presentation of the

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29

factor reversal phenomenon will be considered under assumption of 5.

In general the homohypallagic production function (or any function which

does not reflect constant return to scale) will not suffice in

equalizingffacfcorpprices.

5. The commodities differ in their labor and land intensities. Thus, food is relatively land intensive while clothing is relatively labor intensive. This means that whatever the pre­vailing ratio of wages to rents, the optimal proportion of labor to land is greater in clothing than in food.

This assumption has been the one most discussed in the literature

because of its implication of non-reversible factor intensities. The

first sentence implies that the production functions of the two good,

two factor case must not be identical. If they are identical for X and Y,

trade will not equalize factor prices (See Figure 9). This is Professor

Samuelson's(1948, p. 175) case where production functions are

identical and trade does not occur because of equal commodity price

ratios.

r L

country 2

courftVy \

Figure 9 - Identical production functions

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30

Laursen (1952) p. 547) points out that in the special case where

relative factor endowments are identical and production function are the

same, we may still have trade because of differing demands (Figure 10).

In any case, factor prices are equalized (regardless of trade).

cooi h

T

OK^2, <-f>or\\r\^ 2.

COOT^Ti^l

v^JI.

Ox lanJz

Figure 10 - Identical production and factor endowments

In general, however, the difference in the production function causes

one of the goods to be labor intensive and the other to be land inten­

sive. The T/L ratio in the labor intensive industry will be less than

the country's factor endowment ratio of T/L while the ratio in the lad

intensive will exceed that of the country involved. Thus, regardless

of the factor price ratio, one of the goods is always labor intensive

while the other is land intensive. As mentioned earlier, Mi nhas has

shown the factor intensiveness of the two goods to be independent of

the factor price ratios only in the case where the elasticities of sub­

stitution between the two factors are equal (jx -J^y)- Thus, he has

generalized considerably the restrictions that must be placed on produc­

tion functions to prevent factor reversals (although assuT ption 3

above still limits us to the Cobb-Douglas function in the constant

returns cases) since the linear homogeneous production function is

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31

J". d u . simply one of many which satisfies the condition of x *=

There are a number of geometric approaches to the reversal

problem. One of the most fruitful has been Lerner*s diagram (1952),

In the Figure 11, we can simultaneously measure the T/L ratios, com­

modity price ratios (in terms of the factors) and the factor price

ratios. In diagram 11a, we can depict factor price ratios in

country 1 before trade as

?J?^ - Oa^/Oa^ Ob^/Ob^.

«.»* b,»

t'\^"tJ«-'

cCrh:

(Li^<

Figure 11 - The Lerner diagrams

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32

Country 2's factor price ratios are P /P = 0a2,/0ag - Ob^/Ob^.

The price of Y in terms of factor L is Oa^ in country 1 and Oa^ in

country 2, while the price of X is Ob^ in country 1 and Oa^ in country 2.

Since P /Py - Ob^/Oa^ Oa^/Ob^ country 2 will export X and country 1

will export Y, causing X's price to rise in country 2 and Y*s price to

rise in country 1. When commodity prices become equal

(Oa,-Ob. Oa 2 » Ob^), factor prices are also equal (Figure lib).

If factor intensities for the two goods are reversed for different

w/r ratios, then factor price equalizations will not occur if the

countries lie on opposite sides of OS in factor intensity. In this case,

the elasticities of substitution differ ( J*x :jt/y ). In country 1, X

is T intensive while in country 2 it is L intensive (See Figure lie).

The ratio of goods prices is equalized at unity but factor prices are

not.

Johnson (1958, chapter 1) borrows Professor Samuelson*s diagram

(1949, p. 188n.) to illustrate the reversal process (Figure 12).

I

€rwlocjmervt$ rahos •for ^

r,

Figure 12 - The Johnson diagram

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33

Just as in the Lerner case, country 1 exports Y and country 2 exports

1 1 2 2 good X (P^ /Py P^ /p ) equalizing factor prices at (w/r)Q when we

are in the range to the left of A (without specialization). If aggregate

factor endowment ratios are separated by an odd number of reversal

(r^ and say r Oiji then export commodities will have the same factor

intensity moving factor prices in the same directions. If the number

of reversals is even, then a Kommodity does not reverse its factor

intensiveness in the two countries (r and say r«„). Factor prices are

convergent or divergent depending on whether or not the labor intensive

commodity is exported by the labor intensive country. Since it is not

in our case, prices diverge.

A reversal of sorts is described by Lancaster (1957, pp. 37-38)

who uses a theorem of "inverse points" to show the case where the factor

described as a labor in country 1 is equivalent in its economic aspects

to land in country 2 (Figure 13) . The endowment of one country is just

the inverse of the other country: for any point P on countyy I's

contract curve there exists a Q on country 2*s, such that commodity prices

are equal but productivities are reciprocal (mppj /mpp_2 l/moo )

In this case, trade does not occur and factor prices remain unequal.

• • counircj

mppT'

coon fry*

Figure 13 - The Lancaster diagram

Page 37: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

'•'i't^

34

Pearce (1959, pp. 725-732) takes a rather topological approach

to the problem: we will consider, however, only a few key equations

in his system. In investigating the general equilibrium approach, he

first establishes the zero profit conditionCDiplxij * t"'4j fj">-i-.-TV) where

the left side of the equation deals with the factor prices and i fac­

tors used in producing good j whose prices ( i ) and outputs (4*3)

are described on the right. In the two good case we will have multiple

solutions to these equations if for non-zero values for the pj and qj

there exist non-zero Xij(i^^ factor used in producing j^^ good) such that

That is, given the X's, we will have two equations and two variables

(dp and dp^). We can express this relationship as

' ^ X t-x. 1 I.

and ll'' 21 are In the non-reversal case, the slopes X2 2 22

unequal so that the onlyysolution to equations ® is dp^ » dp^ = 0

(See Figure 14). If for-sdmetfiactorcprtceiratiolwe do have a reversal,

then the slopes are X^i/X2i - -^12/^22 ^ ®*^°^ ^^ ^® Lerner diagram

(Figure 14b).

*^p»-")<r. ^p'

^^"^J^^ Figure 14a

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35

Figure 14b

dpz

<)pi

Figure 15 - Geometric conditions for multiple solution

For the three dimensional case (3 factors and 3 goods) we will

have three planes in the dp^, dp«, dp^ space related to the factor

"intensities" of the three goods. If these three planes intersect in

a line or a plane then wacwill have a multiple solution and reversals

occur. In Figure 15, they intersect in a line implying a reversal. In

general, however, three planes intersect in only a point.

Thus the general condition precluding factor reversals is that

points 0, R and S should never lie on the same straight line. If they

do, a reversal has occurred. In the three factor, three goods case we

can extend this result to say that if points 0, R, S, and say, T lie in

the same plane, a reversal will occur (Pearce and James, 1951-1952, p. 114)

Thus, if K, L and T are the factors of production and 1, 2, and 3 are

goods, then there will not be a reversal unless points (K , L^, T ),

(K^.L^, T^), and (K^, L^, T^) all lie in the same plane for some factor

price ratio.

Page 39: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

36

Consider three identical production spheres in the KLT space

whose centers lie on a straight line parallel to the KT plane. Their

centers are on a line whose projection in the KT plane forms the base

of an equilateral triangle with the apex at the origin. Any line parallel

to the line through the origin of the spheres and tangent to their ex­

terior on the side nearest the origin satisfies the ORST condition above

(any line and a point suffice to specify a plane) and implies that a

factor reversal occurs. A two dimensional projection of this result

can be seen in Figure 16. In country 1 the slopes of the tangent lines

are the same in the KT direction (with K and T's factor prices equalized

there); the ratios of factor prices K and L, and L and T are different,

however, and the reversal is evident. Pearce shows in the mathematical

appendix (1951, p. 120) that the necessary condition for the non-

reversal case is that of non-vanishing Jacobian.

Figure 16 - The Pearce and James diagram

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37

An interesting possibility where the production functions

became identical in a short range but did not reverse might be

depicted in Figure 17. This is an interesting geometric case al­

though to the mathematician, it is very likely of the persona non

grata variety.

\

T L

O

r

no -irade bo4 -.-fflLC^cr prices eq\)oJiic<^ if counhry i oind 2.

»1 l! t

11 It I

Figure 17 - A near reversal

In general, what can be said about many factors and the

importance of factor reversals? Caves (1960, pp. 91-92) imputes to

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38

Harrod the conclusion that if there are N factors of production, the

nximber of factor intensity comparisons for two commodities is

NI/2I (N-2)I which rises more than proportionately to N. Thus, with

multiple factors the probability of intensity reversals increases.

Harrod (1958, pp. 245-250) emphasizes that factor reversals are

of great significance empirically. A much more thorough study is the

one by Minhas (1962). He shows that the mere possibility of factor

reversals may be of little consequence unless they occur in the relevant

factor-price range. His studies indicate that this is, in fact, what

has occurred in U. S. - Jfipanese trade.

6. Land and labor are assumed to be qualitatively identical inputs in the two countries and the technological production functions are assumed to be the same in the two countries.

This section will deal only with the case in which the production

functions of the goods differ between countries. Minhas (1962, p. 155)

Introduces a natural efficiency parameter and into his production

function by setting A + a = ^ "^^ and A^ ^^ 'djc: thus j

Consider the case where ^^/'^ , >yx2^Xy2' ^^^^ implies that the

price ratio (P /P ) to the right of R will lie south of RS (the equal

efficiency case) in Figure 18. If the efficiency differences are

significant, the directions of trade may even change.

Page 42: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

39

l-S^

Figure 18 - Efficiency differences

In a sense one can think of the factor reversal as an alteration

of the production function: the same good is produced at different

factor-price ratios with vastly different T/L ratios.

Findlay and Grubert (1959) have analyzed the case where neutral

technological progress occurs in one of two industries. Bardhan has shown

that this inter-temporal difference in production functions due to tech­

nical progress ±&'i perfectly analogous to the interspatial efficiency

differentials growing out of variable production functions between

countries. If instead of time periods 1 and 2 in the technical progress

sense, we have countries 1 and 2 with differing production functions,

then we can see the factor price differences which will emerge. The

casesiiliustrated are listed below (See the increasing and decreasing

returns cases above).

In Figure 19a we have countries 1 and 2 being equally efficient

in good Y but country 2 has an advantage in good X and will specialize

in it. Goods prices are equalized at Ob although factor prices are not

(Pj /P - OA1/OA^^^ - 0C1/0C^2)> .

The price of labor is higher in the country which specializes in the

labor intensive commodity.

Page 43: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

Wtv^

40

J^*u>4rt

Figure 19a - The Lerner diagram showing efficiency differences

^ I w l r f

Figure 19b - The Lerner diagram showing efficiency differences

In Figure 19b both are equally efficient in X but country 2 has

an advantage in good Y, causing it to specialize. Goods prices are

equalized at OA, but land in country 2 has a higher return than in

country 1.

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41

Clemhout <1963) shows that differences in production functions

are identical to the artificial efficiency arising out of tariff

Imposition. Hence, the previous analysis is of general applicability,

7. All commodities move perfectly freely in inter­national trade, without encountering tariffs or transport cost, and with competition effectively equalizing the market price-ratio of food and clothing. No factors of production can move between the two countries.

Kindleberger (1963, p. 141) has shown that the tariffs and trans­

port costs will cause a divergence in commodity price ratios in

international trade.

T

o,

Figure 20a - The Kindleberger diagrams

^N V J

pJ'icc oi V in line c^ L b afc»ovc tariff - Oy B

L Figure 20b - The Kindleberger diagrams

Page 45: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

42

This can readily be seen in the case of good Y in Figure 20a. Either

a tariff or transport cost causes it to have a price of 0 A in country 2

and price 0 C in country 1. Under frictionless trade the price would

have been 0 B in both countries which would have equalized factor prices.

Thus these impediments cause country 2 to export less Y to country 1.

In Figure 20b the price divergences are measured w/r to L.

The second part of the assumption deals with the competitive

aspects of international trade. Baldwin (1948) deals with the case where

country 1 is a monopolist or price maker while country 2 is a price

taker. First he derives the offer curve for country 2 which has a com­

parative advantage in good X (which is exported in normal demand conditions)

(Figure 21).

X H

n \i

Figure 21 - Baldwin's monopoly case

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43

In Figure 22 country 1 has a transformational curve R V upon which

we can superimpose country 2* offer curves (since country 2*8 offer

curves are independent of country l*s production). Thus, if we choose

point o, then to the left of o, country 2 will offer X for Y (and

similarly for every point on country I's transformation function). The

total of these offer curves can be enclosed in an envelope function which

gives the maximum attainable X for any given Y.

COun+ru I5

Figure 22 - The envelope

Notice that the slope of the offer curve at point U equals the slope

of the transformation function implying no trade at that point.

Furthermore, the envelope has the property that the slope of the

offer curve at its tangency with the envelope will always equal the

slope of the transformation curve. This theorem makes the diagram

quite useful to factor price analysis.

By superimposing country I's indifference curves on the diagram,

we can find its maximum satisfaction point (point Q) at the tangency of

the envelope and indifference curve I-, • The offer curve tangent to Q

goes through point 0 on the transformation curve which is the production

optimizing point for country 1. The monopolist will set the price

Page 47: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

44

equal to the slope of the line going from Q to 0, thereby inducing

country 2 to supply OZ of X in exchahge for OZ of good Y. Thus, the

monopolist exports Y and imports X. The marginal revenue for the

monopolist will be the slope of the offer curve at Q, while its mar­

ginal cost is the slope of transformation curve at point 0. Bnt

Baldwin (p. 754) proved that these slopes were equal so that

mr » mc for the monopolist. (The international price for Y/X he set

at QZ/OZ, which exceeds these values.) In country 2, the price

QZ/OZ equals marginal cost so that although commodity prices are equal,

factor prices are not: the price maker disrupts Professor Samuelson*s

conclusions.

The final portion of the assumption postulates that the factors

of production will not move between countries. Samuelson (1948, p. 176)

and Laursen (1952, p. 547) show that factor mobility will perform the

function of equalizing factor prices by eliminating the factor endow­

ment differentials between countries.

In the symmetrical case depicted in Figure 23, points H and I

depict the autarkic positions in countries 1 and 2. Since the price

of labor is highest in country 2 and the price of land is highest in

country 1, BC of labor will move from country 2 to country 1

(BC - 1/2AC and EF - 1/2DF).

Page 48: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

*** coonWt^ X 45

courrhrcji

Figure 23 - Factor mobility

Factor prices are equalized and trade sCpps at point M. Actually this

factor mobility assumption merely allows us to prove the much stronger

theorem that movements of goods suffice to equalize factor prices.

8. Something is being produced in both countries of both commodities and with both factors of production. Each country may have moved in the direction of specializing 6n the commodity for which it has comparative advantage, but it has not moved so far as to be specializing completely on one commodity.

This specialization assumption is very important and has been

touched upon in most of the preceding discussion (See the discussion of

increasing returns). Since the marginal products of the factors depends

only on the factor ratios used in production, then it is obvious that

the endowment ratios of each country place a limit on the possible

factor price adjustment.

In general we can say that non-specialization implies that no

country produce less goods than the total number of factors of production.

As Laing (1961) has pointed out, greater divergences are permitted in the

factor endowment ratios as the production coefficients in the two goods

case show greater disparity. For example, in Figure 24 good Y is land

intensive while good X is labor intensive. The line 0 C shows the most y

extreme T/L ratio which can be used in the production of Y without the

country specializing.

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^HRr^'' ^HRr^''

46

<:ourTtry

ttP'pardW AbOxP

Figure 24 - The Laing diagram

0 E is parallel to 0 G. If the 0 origin of country 2 is at H, then

trade will occur and factor prices will be equalized at P in country 1

and P* in country 2. It is clear that the area bounded by 0 G, the

0 0 contract curve in country 1 and 0 E is the only permissible range

for the H points. If a country*s factor endowment ratio places its

0 axis at H', then country 2 will specialize in Y and factor prices

will not be equalized. Clearly, As production functions become

similar, the contract curve approaches the diagonal 0 0 and the y X

region of eligible points for country 2*s factor endowments consistent

with non-specialization collapses into a line. This analysis is

roughly comparable to Travis's theorem of corresponding points and

the eligible possible division of factor endowments between two

countries. The Travis analysis is more readily amenable to stochastic

analysis since we have two areas for consideration: a factor price

Page 50: THE ASSUMPTIONS OF THE FACTOR PRICE EQUALIZATION …

47

equalization region without specialization and the rest of the

rectangle (this "area visualization" is useful probabilistically if

factor endowments are distributed at random). The case will not

be dealt with geometrically, however, In any case, we can say that

specialization will not permit the price of the abundant factor in

each country to increase enough to equalize the factor price ratio.

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CHAPTER V

CONCLUSION

The eight formal and one implicit hypotheses which Professor

Samuelson used in his proof have been analyzed in their logical

context. We are now prepared to classify them as either inessential,

empirically restrictive, or necessary.

Assxjmptions 1, 2, and 3* were shown to be inessential in the

general proof. The Samuelson proof can easily be extended to K

countries merely by adding equations and unknowns. The probability

that specialization will occur increases but this is related to

peculiarities of the production function and variations in endowment

ratios rather than country numbers. Similarly, the only general

restrictions on the N commodities and M factors case is that N^M.

Though improbable, equalization can occur even when N-' M, as shown

by Vanek. The implicit assvraiption that factor supplies were per­

fectly inelastic to factor prices can easily be modified by merely

adding appropriate functional relationships.

Assumptions 6 and 7 can be classified as empirically

restrictive. The hypothesis that land and labor are "qualitatively

identical" is a difficult proposition to substantiate in any given

situation and approaches a pseudo question. The transport cost

assumption can be relaxed without disrupting the theorem's result

but it narrows the geographical relevance from countries to areas

within countries.

Assumption 3", 4, 5, and 8 are considered necessary for the

proof of the theorem. Linearly homogeneous production functions

occupy a central position in the proof. Any other degree of

homogeneity (p) would lead to under- or over-exhaustion of total

48

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49

product when factors were paid their marginal return. Euler's theorem

holds where p •• 1. The law of diminishing marginal productivity is

used only to prevent country specialization. It would be possible to

have factor price equalization with specialization but the probability

approaches zero. A reversal 6£cfactor intensities at different factor

price levels is prohibited if the proof is to hold.

This paper has attempted to provide a framework within which

some very eclectic writing in the field of international trade theory

could be unified. Second, it is suggested that transport costs can be

incorporated into the factor price equalization theorem, although at

some loss of generality.

(TEXAS TECHNOLOGICAL COLLEwL

LUBBOCK, TEXAS i-IBRARY

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