Price Equalization
The factor- price equalization theorem may be stated as other things being equal free international trade of commodities like factor movements, causes absolute returns or prices of factors to be identical in each participating country. When the absolute returns become equal then relative factor prices must be identical under the homogeneity conditions.
There are various ways of demonstrating the factor price equalization theorem. The most commonly adopted exposition is however, in terms of the Edgeworth bowled box.
An Edgeworth bowled boss diagram to demonstrate the tendency of complete factor price equalization has been drawn (see figure) with the following assumptions.
1. A double model is dealt with. Thus two countries A and B are assumed to eb producing two goods X and Y using two identical factors of production labour and capital.
2. Good X is capital intensive good Y is labour intensive
3. The product functions in both courtiers are equality identical and perfectly homogeneous.
4. There is a constant return to scale.
5. Perfect competition within both the product and factor markets exists in each country.
6. Trade is free and costless, that is there is absence of transport costs and other trade barriers.
7. The number of factors is equal to the number of good. Thus in the two commodity model only two factors labour and capitals are assumed.
8. Though in both countries factor differ in quantity proportions (country A is capital abundant A and B is labour abundant) they are qualitatively similar.
9. The geographical specialization is incomplete as both goods (X and Y) continue to be produced in the trading countries (A and B) even after free trade has begun.
10. Consumer preference and tastes are identical and unchanged in both the countries thus at a given commodity price ratio (Px/Py) the two goods (X and Y) will be demanded in the same proportion in each country as the commodity demand patterns are identical.
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