We also assume that steel production is capital-intensive and clothing production is labor-intensive. Countries have comparative advantages in those goods for which the required factors of production are relatively abundant and cheap locally. Classical trade theory always took it for granted that free mobility of factors of production between different regions would tend to equalize the relative and absolute prices of productive services in the different regions. Given these factor-endowments, in country A capital will be relatively cheaper. This is the Heckscher-Ohlin theorem. Complete or Partial Factor Price Equalization: There are differences of opinion among trade theorists to the question whether commodity movement will equalize the factor prices completely or partially. Difference in Preferences or Demands for Goods: Against Hecksher-Ohlin theorem, it has also been pointed out that differences in tastes and preferences for goods or, to put it in other words, differences in pattern of demand also give rise to trade between the countries.
You can also find us on , and. Then, under these circumstances, contrary to its factor-endowments, the country many export labour-intensive goods and import capital-intensive goods. Assume that there is a relative abundance of capital and scarcity of labour in U. Indeed, according to Ohlin, international trade in commodities serves as a substitute for international mobility of factors. For example, a country where capital is abundant but labour is scarce will have comparative advantage in the production of capital intensive goods that require lots of capital but little labour. Similarly on the basis of relative factor intensities, goods may be grouped as capital intensive or labour intensive or land intensive goods.
In countries with an abundance of capital, wage rates tend to be high; therefore, labor-intensive products, e. With this they are also able to develop their own technical know-how, managerial and entrepreneurial ability. As regards India, it is evident from Figure 44. However, according to Ohlin, the classical analysis presumes it to apply to a single market in a country and ignores the space factor whose introduction is crucial for explanation of trade between regions. In symbolic terms: Thus the differences in factor endowments cause differences in factor prices and therefore account for differences in comparative costs of producing different commodities.
Fourth, as has been pointed out by Prof. Think of the basic production materials, as we know them in nature, labour and capital; natural resources and auxiliary resources, labour forces and money to invest in industry, for instance. It is worth mentioning here that the pattern of import trade of the developing countries has changed in the last several years and now consists of greater quantity of various forms of capital goods and less of textiles. The boxes and contract curves are, of course, the same. It will be observed from Figure 23.
Ricardo thought that the differences in labour efficiency alone accounted for the differences in comparative costs. Hence there is no possibility of trade between the two countries on the basis of Heckscher-Ohlin theorem. Let tt be the commodity price ratio i. Ricardo and others who followed him explained differences in comparative costs as arising from differences in skill and efficiency of labour alone. As regards India, it is evident from Figure 23.
In other words, factor prices will be completely equalized in the two countries. As a result of trade India has also gained as she has reached a higher community indifference curve. A will lower the prices of machines in India and raise them in U. Such a case is illustrated in figure 2, which contains the same production possibility curves as in figure 1, and good A is still the capital intensive good and good B the labour intensive good. When production is labour-intensive, it is wise to purchase this from other countries and to import it. This leads to a comparative advantage, with which the highly developed country will have a business sector in technology and the developing country a labour-intensive business sector.
As regards India, as shown in Figure 23. It will be seen from Fig. This allows small countries to trade with large countries by specializing in production of products that use the factors which are more available than its trading partner. It is worthwhile to note that trade would achieve complete factor price equalisation only when some conditions and assumptions are fulfilled. In the sixties, both of these aspects developed in the Netherlands.
In the long-run equilibrium under conditions of perfect competition, relative prices of commodities, as determined by demand and supply, are equal to average cost of production. First, it rescued the theory of international trade from the grip of labour theory of value and based it on the general equilibrium theory of value according to which both demand and supply conditions determine the prices of goods and factors. It will be observed that with terms of trade line tt, U. To produce more of good B, the producers in country I need, more capital. Equalisation of Factor Prices: As explained above, trade takes place when relative prices of commodities differ between countries due to difference in comparative costs. O model directly follows when we define factor abundance in terms of factor prices and it may follow or may not follow when we define factor abundance in terms of factor proportions.
Still other commodities require relatively more land than capital and labour and are therefore called land-intensive commodities. At the time, his model promoted free trade between countries; trade is advantageous for both parties. It is now known as the , one of the standard model economists use to debate. If the various countries could not exchange the products of their specialised labour, each of them would have to be self-sufficient i. The cost of production of a commodity, as is well-known, depends upon the prices paid for the factors of production employed in the production of that commodity.
This means that in the determination of factor-prices supply outweighs demand. The same applies to the price of capital. In 1933 Ohlin published a work that made him world-renowned, Interregional and International Trade. The Rybczynski theorem is derived assuming that output prices remain constant. As this is contrary to the popularly held view, this is known as Leontief Paradox. For when all factor prices were everywhere the same, there would no longer be any reason for trade and with the cessation of trade, and there with the extinction of the demands which brought about the price equalization, the original disparities in factor equipment would immediately reassert themselves. Goods that require inputs that are locally abundant will be cheaper to produce than those goods than require inputs that are locally scarce.