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

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A Y P1 P1 YB O 234 International Business- Dr. R. Chandran therefore, not possible to say anything about factor prices on the basis of factor endowments alone. It would thus be more fruitful to study factor abundance in terms of physical amounts of the factors available in two countries. b) Suppose country A has more capital than labour, and country B has more labour than capital. Taking into consideration the differences in factor endowments, we can draw a production possibility curve of these two countries (AA1 of country A and BB1 of country B) with respect to the goods ‘X’ and ‘Y’ of which ‘X’ is labour intensive and ‘Y’ is capital intensive. This is shown in the following diagram. S S1 A1 P1 The resources endowment in county A is such that with the given total resources of labour and capital, it can produce more of capital intensive goods of ‘Y’ over ‘X’. Similarly, country B can produce more of labour P2 Y R Only for Private Circulation X

235 International Business- Dr. R. Chandran intensive goods ‘X’ than capital intensive goods ‘Y’ and thus has an advantage in the production of ‘X’. The production possibility curve AA1, of country A shows relative abundance of capital while the production possibility curve BB1 of country B shows relative abundance of labour. Thus country A will have a bias towards the production of capital intensive goods ‘Y’ while country B will be more inclined to produce labour intensive goods ‘X’. The nature of this bias is illustrated in the diagram. If both countries produce both the goods in the same proportion, it will be represented by the ray OR. The production of country A will be represented by the point S while that of country B will be represented by point S’ on their respective production possibility curves. The slope of country A’s production possibility curve at S’ is steeper than the tangent P1P1 than the slope of the production possibility curve of country B at point S shown by the tangent P2P2. This implied that good Y is cheaper in country A than in country B and that good X is cheaper in country B than in country A. As it is clear from the respective price lines P1P1 and P2P2, the operating cost of expanding production of goods Y is lower in country A than country B and vice-versa for good X. This shows that the capital rich country A has a bias in favour of capital intensive goods Y and the labour abundant country B has a bias in favour of prevailing Labour intensive goods X. Comparison of Ricardian and Factor Endowment Trade Models Ricardian Heckscher-Ohilin One factor model (labour) Two factor model (labour and capital) Comparative advantages on the basis Comparative advantage is of production conditions along with determined by the production the market demand pattern of goods, condition alone and it leads to because the price determined the export. demand for goods may not always lead to export Classical theory of international trade is totally different from internal trade and hence requires a separate theory to explain the causes the trade Heckscher-Ohilin theory regards international trade as arising from differences in factor endowments and deals with it specific to international trade Ricardian theory does not take factor More realistic theory as it is based on Only for Private Circulation

A<br />

Y<br />

P1<br />

P1<br />

YB<br />

O<br />

234<br />

<strong>International</strong> <strong>Business</strong>- <strong>Dr</strong>. R. <strong>Chandran</strong><br />

therefore, not possible to say anything about factor prices on the basis of<br />

factor endowments alone. It would thus be more fruitful to study factor<br />

abundance in terms of physical amounts of the factors available in two<br />

countries.<br />

b) Suppose country A has more capital than labour, and country B has more<br />

labour than capital. Taking into consideration the differences in factor<br />

endowments, we can draw a production possibility curve of these two<br />

countries (AA1 of country A and BB1 of country B) with respect to the<br />

goods ‘X’ and ‘Y’ of which ‘X’ is labour intensive and ‘Y’ is capital<br />

intensive. This is shown in the following diagram.<br />

S<br />

S1<br />

A1<br />

P1<br />

The resources endowment in county A is such that with the given total<br />

resources of labour and capital, it can produce more of capital intensive<br />

goods of ‘Y’ over ‘X’. Similarly, country B can produce more of labour<br />

P2<br />

Y<br />

R<br />

Only for Private Circulation<br />

X

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