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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
                                         1
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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.
                                                                1
          * 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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