Page 77 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 6 : Rybczynski Theorem

good) is at B and F. Cloth is the exported good while steel is the import-competing good. Once, there Notes
is increase in the supply of labour, we will have a new box of the size of AEFD, where CE measures
the increase in labour force.
Initially, the country produces at point P on its contract curve APB. The factor intensity in the
production of cloth, will then be AP, and the factor intensity in the production of steel will be BP.
When the country gets an increase in labour supply (equal to CE) with no change in capital stock, the
country would move towards a new production point, R on its new contract curve ARF. What are the
effects of this movement on factor prices, product prices, production levels, terms of trade, etc ?
D Labour B Steel F Steel

Capital R Capital

P

A Labour C E
Cloth
Figure 6.2: Increase in Labour Supply : Rybczynski case.
You will notice, first of all, that there is no change in factor prices. The factor intensities in the production
of the two goods remain unchanged. Originally, the factor intensity in cloth production was PA and
now it is RA; in the production of steel, it was BP earlier, and now it is FR (FR is parallel to BP). This
means that factor price ratio has remained unchanged. (This would prevent factor price equalization
from taking place if the labour abundant country experiences labour force increase and the capital
abundant country experiences increase in its capital stock). Since factor prices are kept constant, the
commodity prices also would remain constant. In moving from point P to R, there is no change in
either factor prices or product prices, and the only change is in the volumes of the two goods produced.
The change in the volume of output produced in moving from point P to R can be measured by the
distance from point A to point P and to point R (in the case of cloth) and from point B to P and from
point F to R (in the case of steel). The distance FR is shorter than the distance BP, which means that
less of steel is being produced at R than at P. In the same way, the distance AR is more than the
distance AP, which must, therefore, mean that more of cloth is being produced at R as compared to P.
All this would, then, mean that if the supply of one of the two factors is increased while the other is
kept constant, the production of the good intensive in the increasing factor will increase in absolute
amounts, whereas the production of the other good would decrease absolutely. The commodity and
factor prices remain constant.

The Rybczynski theorem has several implications to welfare, terms of trade, commodity
and factor prices, etc. But its implications to factor-price equalization theorem is rather
clear cut, i.e, if the supplies of the abundant factor of production expands rapidly, it could
keep the factor price ratio in the country constant, preventing factor-price equalization
among countries from taking place.

In this case, what has happened, is as follows. The amount of labour has increased, and all the new
labour has gone into the labour-intensive industry (viz. cloth). From the capital intensive industry
(viz. steel) not only capital but also some labour has moved out into the labour intensive industry.
This is reflected in the fact that the production of cloth has expanded, while that of steel has contracted.
If the labour force continues to expand indefinitely, the country would soon become completely
specialized in the production of cloth.

LOVELY PROFESSIONAL UNIVERSITY 71