1. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

3. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

4. Introduction Harry Johnson (1923-1977)
International Trade & the World Economy;  Charles van Marrewijk
Introduction
Harry Johnson ( )

5. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

6. Factor price equalization (FPE)
International Trade & the World Economy;  Charles van Marrewijk
Factor price equalization (FPE)
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
Corollary
In 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.

7. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

8. Unit value isocost line:
International Trade & the World Economy;  Charles van Marrewijk
The Lerner diagram
Unit value isocost line:
Unit value isoquants:

9. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

10. From factor prices to final goods prices
International Trade & the World Economy;  Charles van Marrewijk
From factor prices to final goods prices
Knowing the prices of inputs w and r gives the unit cost line
There is only isoquant for good M which touches it
one
This determines the price pm
exactly L K
1/r
1/w
Similarly, there is only isoquant for good F which touches the isocost line; this determines the price pf
one
exactly
M = 1/pm B
F = 1/pf C

11. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

12. From final goods prices to factor prices
International Trade & the World Economy;  Charles van Marrewijk
From final goods prices to factor prices
Given the prices of final goods pm and pf the unit value isoquants are determined exactly. They are drawn here in the figure
There is only isocost line which touches these two isoquants
one
This determines the values 1/r and 1/w
exactly K
M = 1/pm
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)
1/r
1/w B C
F = 1/pf L

13. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

14. Stolper - Samuelson proposition
International Trade & the World Economy;  Charles van Marrewijk
Stolper - Samuelson
Stolper - Samuelson proposition
In 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.

15. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

16. International Trade & the World Economy;  Charles van Marrewijk
Graphical analysis
An increase in the price of manufactures increases the rental rate and reduces the wage rate

17. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

18. The magnification effect
International Trade & the World Economy;  Charles van Marrewijk
The magnification effect
Jones magnification effect
In 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

19. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

20. Application: globalization, low wages, and unemployment
International Trade & the World Economy;  Charles van Marrewijk
Application: globalization, low wages, and unemployment
The Stolper-Samuelson result was at the center of the ‘globalization’ debate; rising wage inequality in USA, rising unemployment in EU

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

22. CHAPTER 5; FACTOR PRICES
International Trade & the World Economy;  Charles van Marrewijk
CHAPTER 5; FACTOR PRICES
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

23. In the neo-classical model:
International Trade & the World Economy;  Charles van Marrewijk
Conclusions
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

24. International Trade & the World Economy;  Charles van Marrewijk
Conclusions
Natural-resource intensive man.; share of exports (%), 1998; Source: ITC