Introduction Factor price equalization The Lerner diagram From factor prices to final goods prices From final goods prices to factor prices Stolper - Samuelson

Introduction

Factor price equalization

The Lerner diagram

From factor prices to final goods prices

From final goods prices to factor prices

Stolper - Samuelson

Graphical analysis

The magnification effect

Application: globalization, low wages, and unemployment

Conclusions

CHAPTER 5; FACTOR PRICESInternational Trade & the World Economy; Charles van Marrewijk

Explanations for trade

Classical 2. Opportunity costs 3. Comparative advantage

Neo-classical 4. Production structure 5. Factor prices 6. Production volume 7. Factor abundance

1. The world economy

New trade 9. Imperfect competition 10. Intra-industry trade

Policy

8. Trade policy

11. Strategic trade policy

12. Int. trade organizations 13. Economic integration

17. Applied trade policy modeling

Economicgeography

New interactions 14. Geographical economics 15. Multinationals 16. New goods, growth, and development

Industrialorganization

Internationalbusiness

Growth theory

Part

IP

art

IIPa

rt I

IIPa

rt I

V

18. Concluding remarks

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


IntroductionInternational Trade & the World Economy; Charles van Marrewijk

Objectives / key terms

Factor price equalization Stolper-Samuelson

Unit value isoquant / iso-cost line Lerner diagram

Magnification effect Globalization debate

Harry Johnson (1923-1977)

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Factor price equalization (FPE) International Trade & the World Economy; Charles van Marrewijk

In a neo-classical framework with 2 final goods and 2 factors of production, there is a one-to-one correspondence between the prices of the final goods and the prices of the factors of production, provided both goods are produced. This implies:• factor rewards known derive prices of final goods • prices of final goods known derive factor rewards

CorollaryIn a neo-classical framework with 2 countries, 2 final goods, and 2 factors of production, international trade of the final goods, which equalizes the prices of these goods in the two nations, also leads to an equalization of the rewards of the factors of production in the two nations, provided both final goods are produced in both nations and the state of technology in the two nations is the same.

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


labor

capital

0

mpM /1

fpF /1

A

B

r/1

w/1

r

w

m

m

1

r

w

f

f

1

Unit valuecost line

Unit value isoquant Manufactures

Unit value isoquant Food

The Lerner diagram International Trade & the World Economy; Charles van Marrewijk

1 wLrKUnit value isocost line:

1;1 FpMp fm

Unit value isoquants:

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Knowing the prices of inputs w and r gives the unit cost line

There is only isoquant for good M which touches it

L

K

1/r

1/w

M = 1/pm

B

F = 1/pf

C

This determines the price pm

Similarly, there is only isoquant for good F which touches the isocost line; this determines the price pf

one

exactly

one

exactly

From factor prices to final goods prices International Trade & the World Economy; Charles van Marrewijk

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Given the prices of final goods pm and pf the unit value isoquants are determined exactly. They are drawn here in the figure

L

KM = 1/pm

F = 1/pf

There is only isocost line which touches these two isoquants

1/r

1/w

B

C

This determines the values 1/r and 1/w

This implies that if trade between two countries equalizes the prices of final goods and these two countries have identical CRS production functions, then the reward to factors of production w and r are also equalized (FPE)

one

exactly

From final goods prices to factor prices International Trade & the World Economy; Charles van Marrewijk

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Stolper - Samuelson International Trade & the World Economy; Charles van Marrewijk

Stolper - Samuelson propositionIn a neo-classical framework with 2 final goods (both produced) and 2 factors of production, an increase in the price of a final good • increases the factor price of the input used intensively in the production of that good, and • reduces the factor price of the other input.

So if e.g. the production of manufactures is capital intensive and the price of manufactures rises:• the rental rate rises and the wage rate falls.

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Graphical analysis International Trade & the World Economy; Charles van Marrewijk

labor

capital

0

0/1 mpM

fpF /1

A

B

0/1 r

0/1 w

A’

B’1/1 mpM

1/1 r

1/1 w

An increase in the price of manufactures increases the rental rate and reduces the wage rate

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


The magnification effect International Trade & the World Economy; Charles van Marrewijk

Jones magnification effectIn a neo-classical framework with 2 final goods, manufactures M and food F, and 2 factors of production, capital K and labor L, with factor rewards r and w, respectively, changes in the final goods prices are magnified in the factor rewards. If we denote relative changes by ~ and assume that the production of manufactures is relatively capital intensive, the following relationships hold:

• if then

• if then

fm pp ~~

fm pp ~~

wppr fm~~~~

wppr fm~~~~

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Application: globalization, low wages, and unemployment International Trade & the World Economy; Charles van Marrewijk

United States

40

90

140

190

240

290

340

1976 1986 1996

0

2000

4000

6000

8000

10000

12000

14000

Wage white-collar Wage blue-collar Imports low-wage countries

The Stolper-Samuelson result was at the center of the ‘globalization’ debate; rising wage inequality in USA, rising unemployment in EU

Application: globalization, low wages, and unemployment International Trade & the World Economy; Charles van Marrewijk

Argument: rising imports from low-wage unskilled-labor countries reduces unskilled-labor intensive final goods price, thus reducing wage rate for unskilled workers (USA) or increasing unemployment (EU)

France

0

1000

2000

3000

1960 1970 1980 1990

Imports from low -w age countries Unemployment

Introduction


The Lerner diagram



Stolper - Samuelson

Graphical analysis



Conclusions


Conclusions International Trade & the World Economy; Charles van Marrewijk

In the neo-classical model:

• one-to-one correspondence between final goods prices and factor rewards

• free trade same final goods prices same factor rewards (FPE)

• price increase of a final good raises reward to input used intensively in the production of that good, reduces reward to other input (St-Sa)

• changes of final goods prices magnified in factor prices (Jones magnification)

• application in globalization debate

• natural-resource intensive manufacturing exports haphazardly spread across the globe

ConclusionsInternational Trade & the World Economy; Charles van Marrewijk

Natural-resource intensive man.; share of exports (%), 1998; Source: ITC

natural-res. int. man.share of exports (%)

14.6 to 77.1 (29)6.7 to 14.6 (31)3.5 to 6.7 (29)1.6 to 3.5 (30)0 to 1.6 (32)

Documents

Introduction Factor price equalization The Lerner diagram From factor prices to final goods prices From final goods prices to factor prices Stolper - Samuelson