Page 50 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

International Trade and Finance

Notes D Labour B Good Y
(K-Good)
P 0

Capital T Capital

P 1 X 0
Y 0 P 0
F
X 1
Y 1 P 1
C
Good X Labour
(L-Good)
Figure 4.3: Decrease in Capital-Labour Ratio in Capital Surplus Country.

Thus, in the capital surplus country—country A—the capital-labour ratio has decreased in the
production of both X and Y goods, as a result of trade. When this is combined with the increase in
capital-labour ratio in the production of the two goods in country B—a labour surplus country, we
eventually get to a point where the capital-labour ratios (or factor prices) are equalized in the two
countries. We will now show this combined result in a composite graph which is drawn in Figure 4.3.
Factor Price Equalization : A Composite Graph
In the succeeding graph there are two boxes, one for each country. The box ABCD is for country B,
the capital surplus country, and the box AEFG applies to country A which is the labour surplus
country. There is a common point of origin at A for good X the labour-intensive good; but for good Y,
the capital-intensive good, the point of origin is at point F in case of country A, and at point X in case
of country B.
The contract curves, in the two countries, are such that good X is labour-intensive in both the countries
and good Y is capital-intensive in both the countries, at all factor price ratios. This applies regardless
of the fact that one country is capital rich and the other is labour rich, because the production functions
of a given good must be the same throughout in all countries, irrespective what the factor price
differences are between the countries.

B Labour C
Good Y
(K-Good)
Capital Good Y
(K-Good)
Labour F
G P 0 R
P 1
X 0 X
Y P P N 1 P
0 0
Capital P 1 0 Y 1 1 Capital
M
T
X 0
A P X 1 Y 0 P 0
Y 1 D
Good X 1
(L-Good) Labour
Figure 4.4 : Factor Price Equalization shown jointly.

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