Chapter 3: Problem 2

Explain how the international movement of products and of factor inputs promotes an equalization of the factor prices among nations.

Short Answer

Expert verified

The international movement of goods allows countries to trade based on their comparative advantage, leading to product price equalization. The international movement of factor inputs, such as labor and capital, results in their more effective global distribution, which in turn leads to the equalization of their costs due to market forces. These two movements collectively contribute to the equalization of factor prices among nations.

Step by step solution

Understanding International Trade and Factor Price Equalization Theorem

Factor Price Equalization Theorem is a theory in international economics which states that when the prices of the output goods are equalized between countries as they move to free trade, then the prices of input goods (i.e., labor, capital) will also be equalized between countries.

Role of International Movement of Products

The international movement of products allows countries to export goods which they can produce more efficiently, and import goods which they produce less efficiently. This promotes trade and economic interdependence among countries, leading to equalization of commodity prices. When the price of the products equalizes, it also impacts the price of the factors of production used in creating those products.

Role of International Movement of Factor Inputs

Similarly, the international movement of factor inputs like labor and capital also helps in the equalization of factor prices. When there is free movement of labor and capital across countries, it leads to their better allocation and utilization worldwide. Workers migrate to countries where wages are higher and capital moves to places where its return is higher. Over time, this results in an equalization of wage rates and capital returns.

Putting it all together

So, the international movement of both products and factor inputs promotes an equalization of the factor prices among nations. As countries trade goods and services, and labor and capital move freely, the prices for these factors of production tend to align more closely due to the forces of supply and demand. This is the core idea of Factor Price Equalization Theorem.

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