Economics Dictionary of ArgumentsHome
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| Factor Price Equalization Theorem: The Factor Price Equalization Theorem (FPE) states that, under certain assumptions, free trade in goods will lead to the equalization of prices for identical factors of production (like wages and capital rents) across trading countries. This occurs even without factor mobility, as trade effectively acts as a substitute for it. Key assumptions include identical technologies and perfect competition. See also Perfect competition, Imperfect competition, Techology, International trade._____________Annotation: The above characterizations of concepts are neither definitions nor exhausting presentations of problems related to them. Instead, they are intended to give a short introduction to the contributions below. – Lexicon of Arguments. | |||
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Robert C. Feenstra on Factor Price Equalization Theorem - Dictionary of Arguments
Feenstra I 1-20 Factor Price Equalization Theorem/Feenstra: Suppose that two countries are engaged in free trade, having identical technologies but different factor endowments. If both countries are diversified and FIR do not occur, then the factor prices (w, r) are equalized across these countries. Feenstra I 1-21 To illustrate this result, we engage in a thought experiment posed by Samuelson (1949)(1) and further developed by Dixit and Norman (1980)(2). Initially, suppose that labor and capital are free to move between the two countries until their factor prices are equalized. Then all that matters for factor prices are the world endowments of labor and capital, (…). The factor prices determine the demand for labor and capital in each industry, and using these, we can construct the diversification cone (since factor prices are the same across countries, then the diversification cone is also the same). Feenstra I 1-23 More generally, for any allocation of labor and capital within the parallelogram 0A10*A2 both countries remain diversified (producing both goods), and we can achieve the same equilibrium prices as in the “integrated world economy.” It follows that factor prices remain equalized across countries for allocations of labor and capital within the parallelogram 0A10*A2, which is referred to as the Factor Price Equalization (FPE) set. The FPE set illustrates the range of labor and capital endowments between countries for which factor price equalization is obtained. In contrast, for endowments outside of the FPE set such as point B’, then at least one country would have to be fully specialized in one good and FPE no longer holds. The FPE theorem is a remarkable result because it says that trade in goods has the ability to equalize factor prices: in this sense, trade in goods is a “perfect substitute” for trade in factors. We can again contrast this result with that obtained from a one-sector economy in both countries. In that case, equalization of the product price through trade would certainly not equalize factor prices: Feenstra I 1-24 the labor abundant country would be paying a lower wage. Why does this outcome not occur when there are two sectors? The answer is that the labor abundant country can produce more of, and export, the labor-intensive good. In that way it can fully employ its labor while still paying the same wages as a capital abundant country. In the two-by-two model, the opportunity to disproportionately produce more of one good than the other, while exporting the amounts not consumed at home, is what allows factor price equalization to occur. 1. Samuelson, Paul A., 1949, “International Factor Price Equalization Once Again,” Economic Journal, June, 181-197. Reprinted in Edward E. Leamer, ed. 2001, International Economics, New York: Worth Publishers, 19-32. 2. Dixit, Avinash and Victor Norman, 1980, Theory of International Trade. Cambridge University Press._____________Explanation of symbols: Roman numerals indicate the source, arabic numerals indicate the page number. The corresponding books are indicated on the right hand side. ((s)…): Comment by the sender of the contribution. Translations: Dictionary of Arguments The note [Concept/Author], [Author1]Vs[Author2] or [Author]Vs[term] resp. "problem:"/"solution:", "old:"/"new:" and "thesis:" is an addition from the Dictionary of Arguments. If a German edition is specified, the page numbers refer to this edition. |
Feenstra I Robert C. Feenstra Advanced International Trade University of California, Davis and National Bureau of Economic Research 2002 |
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