Question

Question 1

(a) Using the example of two nations, explain the effect of international trade on the difference in factor prices between the nations.

(b) Using the example of two nations, explain the effect of international trade on relative factor prices and income within both nations.

Answer 1

Factor Prices & International Trade

Factor prices are always matter of concern of countries with their international and even domestic trade. The abundance of factors of production determines the advantage of the country in production and exports. Many factors being necessary for the production of different commodities, the availability and prices for the factors is an important factor deciding what to produce with better advantage.

a) USA is abundant with capital and India with labor. US have to face expensive labor supply when compared to the abundant and cheap capital available. The factor abundance will reduce the price of that factor making the production with a large amount of that particular factor becoming profitable. US produce capital intensive products to take advantage of the cheap capital available. Machinery, automobiles are example of capital intensive production. This will benefit them in international market also. They can export their capital intensive goods to the countries where capital is more expensive. India, where labor is more abundant and cheap than capital, the production and export is more on labor intensive products. Indian service sector growth is an example for this. Exploiting the cheap and abundant labor than the expensive capital to produce and export. India exports services to other nations including US where labor is less abundant and expensive. This creates advantage in the international market for India under labor intensive production.

b) China and India are best examples to consider and compare between the relative factor prices and income. Like India, the labor intensive country has an advantage in relative factor prices. The labor in China is relatively cheaper than India. Relative factor prices compare the prices with similar factors. Even both countries are labor intensive; the relative price gives an advantage to China to produce cheaper than India even in labor intensive goods.

This attracts foreign markets to the country and to produce there using the relatively cheap factor of production labor, when compared to India. This increases the income of the country by giving extra employment opportunities to the labor force which is the factor of production. These examples explain the importance of factor prices and the relationship between production and exports in the international market too.