International-Business-Dr-R-Chandran-E-book
International-Business-Dr-R-Chandran-E-book International-Business-Dr-R-Chandran-E-book
C A P A C I T Y Y A B R C P K M O Y S E Q F X1 232 International Business- Dr. R. Chandran L N LABOUR C B In the figure, we have two isoquants YY and XX showing the production of one unit each of goods ‘Y’ and goods ‘X’ in each one of the two countries. These isoquants are common to both countries showing that production functions are same in both countries. According to these isoquants, goods ‘Y’ are capital intensive and goods ‘X’ are labour intensive. Country A is rich in capital and hence capital here is cheaper relative to labour, which is shown by the relative factor price line AA. On the other hand, country B is labour rich and hence the relative price of labour is low, a fact shown by the relatively flatter factor price line BB. G Y H A Only for Private Circulation X X
233 International Business- Dr. R. Chandran Consider country A whose factor price line AA is tangential to the isoquant YY at the point E. Since the isoquant YY represents one unit of goods ‘Y’, we find that in country A, one unit of goods ‘Y’ can be produced with OR of capital and OS of labour, the factor price ration line shows the rate at which one factor can be exchanged for the other. Thus on the factor price line AA, with points A and E being on the same line, OS of labour is worth RA of capital and OR of capital is worth SA of labour. As we have seen, the cost of producing one unit of goods ‘Y’ is equal to OR of capital plus OS of labour. It is found that OS of labour, we find that the cost of producing one unit of goods ‘Y’ is equal to OR of labour SA of labour which has been substituted for OR of capital which is equal to OA of labour. By the same reasoning, the cost of producing one unit of goods ‘X’ in country A is OK of capital plus KA of capital (because OL of labour is worth KA of capital) and hence equal to OA of capital. In terms of labour alone, this cost is equal to OL of labour plus LA of labour (because OK of capital is worth LA of labour) and hence equals OA of labour. Now, let us examine the cost of producing one unit of both types of goods in country B. Since country B is labour rich and therefore labour is relatively cheaper here, the factor price ratio line BB is flatter than AA. This price line BB is tangential to the isoquant YY at the point F. This shows that the cost of producing one unit of ‘X’ in country B in terms of capital alone. To find this we draw a price line CC parallel to and below the price line BB in such a way that it is tangential to the isoquant XX at point the H. The price line CC represents the same factor price ratio as the line BB as the two are parallel. At point H the cost of producing one unit of ‘X’ in country B is OM of capital plus ON of labour. Since on this price line CC, ON of labour corresponds to MC of capital, the price of one unit of ‘X’ is equal to OC of capital in country B. Thus, in country B the cost of producing one unit ‘Y’ is OB in terms of capital while for ‘X’ it is OC in capital alone. Hence in country B it is more expensive to produce ‘Y’ than to product ‘X’ in the same quantities as OV>OC. The above analysis shows that country B has a cost advantage in production of ‘X’ and it is relatively cheaper to produce ‘Y’ in country A. This fact establishes the Heckscher-Ohilin theory, that a country abundant in capita will export capital intensive goods and a country abundant in labour will export the labour intensive goods. One of the major drawbacks of this analysis is that it defines factor abundance in terms of factor prices. This is not free from flaws due to the fact that factor prices do not depend on abundance or scarcity of factor supplies alone, but they are also influenced by demand factors. It is Only for Private Circulation
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- Page 241 and 242: Factor Conditions PURCHASING POWER
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- Page 255 and 256: 3. Freedom loving and self-reliant.
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232<br />
<strong>International</strong> <strong>Business</strong>- <strong>Dr</strong>. R. <strong>Chandran</strong><br />
L N<br />
LABOUR<br />
C B<br />
In the figure, we have two isoquants YY and XX showing the production of<br />
one unit each of goods ‘Y’ and goods ‘X’ in each one of the two countries.<br />
These isoquants are common to both countries showing that production<br />
functions are same in both countries. According to these isoquants, goods<br />
‘Y’ are capital intensive and goods ‘X’ are labour intensive. Country A is<br />
rich in capital and hence capital here is cheaper relative to labour, which is<br />
shown by the relative factor price line AA. On the other hand, country B is<br />
labour rich and hence the relative price of labour is low, a fact shown by the<br />
relatively flatter factor price line BB.<br />
G<br />
Y<br />
H<br />
A<br />
Only for Private Circulation<br />
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X
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