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Unit 2: Theories of International Trade
In this figure, labour is shown on the X-axis, and capital is shown on the Y-axis. WW is isoquant* notes
showing production of 100 watches, and SS, is the isoquant showing production of 100 shirts.
AB and CD are Isocost** lines for USA. These are parallel straight lines, which means their slope
is same and, (since slope shows price ratio) these isocost lines are showing the same price ratio.
These isocost lines are inclined towards OY-axis, showing that in USA, capital is cheaper in
relation to labour. Likewise ZT and Z T are isocost lines for India. These are inclined toward
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OX-axis, showing that, in India, labour is cheaper in relation to capital. These lines are also
parallel and showing the same price ratio.
figure 2.3: Price criterion of relative factor endowment
Thus,
OZ = OZ 1
OT OT 1
Isoquants WW and SS are intersecting each other only at point E. This implies that there is no
reversal of factor intensity. Or that in both USA and India, production of watches is capital
intensive, and production of shirts is labour intensive. This conclusion is based on the assumption
of Heckscher-Ohlin theory that both in USA and India, production function of watches or of
shirts is similar.
The diagram shows that, in case of USA, isocost line CD and isoproduct curve WW for watches
are tangent at point H. So that, for USA Production Cost for 100 Watches = OF Capital + ON
Labour
As regards the production of shirts, we find isocost line AB and isoproduct curve SS are tangent
at point J. So that for USA,
Production Cost of 100 shirts = OF Capital + ON Labour.
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* An Isoproduct curve is a curve that shows different possible combinations of two factors of production, like capital and
labour, yielding the same amount of output.
** An Isocost line is that line which shows the various combinations of factors which can be obtained at the same cost. It is
also called budget line. It shows what possible combinations of factors a firm can obtain at the same cost. Isocost line also
shows cost-ratio of the factors.
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