International-Business-Dr-R-Chandran-E-book

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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
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