Rybczynski Theorem

Rybczynski Theorem discusses the effect of economic growth on a nation's trade. It states that at constant prices, an increase in one factor endowment will increase by a greater proportion the output of the good intensive in that factor and will reduce the output of the other good. An increase in the supply of labour expands production possibilities disproportionately in the direction of the production of labour-intensive good (wheat), while an increase in the supply of capital expands them disproportionately in the direction of the production of capital- intensive good (cloth). Suppose the supply of capital increases by 10% and that of labour is unchanged. If both goods continue to be produced, then factor prices will not change (because of factor-price equalisation theorem) and so the techniques of production will also not change. As a result of increase in capital, (a) the output of both goods cannot rise by 10% because this would require 10% more labour, and the supply of labour has not changed; (b) output of both goods cannot rise by more than 10%, (c) output of both goods cannot fail to rise by 10% because otherwise the increased capital could not all be utilised; (d) thus the output of one rises by more than 10% and that of the other does not. Because cloth is capital intensive, it must be cloth output that rises more than 10%. The labour supply has not changed, but the cloth industry has expanded and so has increased Us use of labour. Therefore, the output of wheat must actually fall. By combining this result with the Heckscher-Ohlin theorem, we can see how economic growth affects a nation's trade. If a country's capital increases by 10%, national income will rise by some smaller proportion, because only part of national income comes from the earnings of capital. This increased income will normally be spent on both goods, so that at constant prices, national demand for both goods will rise by less than 10%. According to Rybczynski Theorem, the supply of capital-intensive good (cloth) rises more than 10%, while the supply of labour-intensive good (wheat) falls. Thus, cloth supply rises relative to demand, and wheat demand rises relative to supply. Now, if the country is capital intensive, then according to the Heckscher-Ohlin theory, it exports cloth and imports wheat, so that the growth of capital causes the country to trade more at each price. Thus, its offer curve shifts outward. If the country is labour abundant, its offer curve shifts inward. The general conclusion is economic growth that accentuates country's relative factor abundance

shifts its offer curve it; economic growth that moderates the country's relative factor abundance shifts its offer curve in.
The Rybczynski theorem displays how changes in an endowment affects the outputs of the goods when full employment is sustained. The theorem is useful in analyzing the effects of capital investment, immigration and emigration within the context of a Heckscher-Ohlin model. Consider the diagram below, depicting a labour constraint in red and a capital constraint in blue. Suppose production occurs initially on the production possibility frontier (PPF) at point A.

Suppose there is an increase in the labour endowment. This will cause an outward shift in the labour constraint. The PPF and thus production will shift to point B. Production of clothing, the labour intensive good, will rise from C1 to C2. Production of cars, the capital-intensive good, will fall from S1 to S2. If the endowment of capital rose the capital constraint would shift out causing an increase in car production and a decrease in clothing production. Since the labour constraint is steeper than the capital constraint, cars are capital-intensive and clothing is labor-intensive. In general, an increase in a country's endowment of a factor will cause an increase in output of the good which uses that factor intensively, and a decrease in the output of the other good.

Stolper-Samuelson Theorem
Stolper-Samuelson theorem deals with the effect of international trade on the domestic distribution of income. The theorem states that an increase in the relative price of labour-intensive good will increase the labour price relative to both commodities prices and reduce the other factor price relative to both commodity prices. In other words, there is a magnified effect of goods prices on factor price. When the price of wheat (labour- intensive good) rises, the wage rate rises more than proportionately. This is so because the price of other factor (capital) actually falls. Suppose the price of wheat rises by 10% and that of cloth remains unchanged. Then the cost of wheat rises by 10%. This cost consists of the cost of labour and capital. In this situation, (a) both these costs cannot ' rise by 10% because cost of labour rises relative to cost of capital; (b) they cannot both rise by more than 10% because then the cost of wheat would have to rise more than 10; (c) similarly they cannot both fail to rise by at least 10%; (d) thus one rises more than 10% and the other does not. As the cost of labour rises relative to that of capital, it is the wage that rises more than 10%, and thus increases relative to both commodity prices. On the other hand, the price of cloth (and so its cost) has not changed. But the price of labour (wage) has increased. Thus, the price of capital must fall, since otherwise the cost of cloth would have to rise. Therefore, the price of capital falls relative to both commodity prices. By combining this result with Heckscher-Ohlin theorem we can see how trade affects domestic income distribution. A country has a comparative advantage in the good intensive to its relatively abundant factor. Free trade will increase the relative price of that good and so, by the Stolper-Samuelson theorem, increases the real income of the relatively abundant factor and reduce that of relatively scarce factor. Since the country as a whole gains from trade, the abundant factor gains more than the scarce factor loses. Thus, there will be a class in the economy which will be permanently harmed by free trade, even though the country as a whole

Considering a two-good economy that produces only wheat and cloth, with labour and land being the only factors of production, wheat a land-intensive industry and cloth a labour-intensive one, and assuming that the price of each product equals its marginal cost, the theorem can be derived. The price of cloth should be: (1) with P(C) standing for the price of cloth, r standing for rent paid to landowners, w for wage levels and a and b respectively standing for the amount of land and labour used. Similarly, the price of wheat would be: (2) with P(W) standing for the price of wheat, r and w for rent and wages, and c and d for the respective amount of land and labour used. If, then, cloth experiences a rise in its price, at least one of its factors must also become more expensive, for equation 1 to hold true, since the relative amounts of labour and land are not affected by changing prices. It can be assumed that it would be labour, the intensively used factor in the production of cloth, that would rise. When wages rise, rent must fall, in order for equation 2 to hold true. But a fall in rent also affects equation 1. For it to still hold true, then, the rise in wages must be more than proportional to the rise in cloth prices. A rise in the price of a product, then, will more than proportionally raise the return to the most intensively used factor, and a fall on the return to the less intensively used factor.

Equalisation of Factor Prices

In Figure 5.1(a), it is assumed that country A's currency is dollars and B's currency is rupees. Under isolated position, one rupee can buy certain amount of B's factor: The curve B is a straight line showing the prices of this amount of factors in country B, and all of them cost one rupee. The curve A denotes the prices in dollars of the same amount of these very factors in country A, during isolation. The cheapest factor in A relatively is placed at the left, then the next cheapest, and so on. As such curve A has an upward slope. Further, the relative position of curve A is determined by the exchange rate between dollar and rupee. When the exchange rate of dollar is say, 1 $ = 20 Rs. then factor price curve A in terms of rupees will be A." This reveals that some factors in country A are relatively cheaper. The factor combinations on the extreme left are very cheap in country A as compared to country B before trade, and when trade takes place these factors are obviously cheaper in A than in B. Thus, A will export goods incorporating larger proportions of these factors in their production function. Likewise, the factors on the extreme right are dearer in A relative to B. Therefore, B will export goods using greater proportion of these factors in their production function. Where two curves A and B intersect, there are intermediate factors about which nothing can be stated a priori. Figure 5.1 (b) represents the change in factor prices led by trade. It is easy to see that cross distance between A' and B narrows down in effect. This means prices of the factors in A have tended relatively and absolutely to approach their prices in country B. Comparing the distance BA in Figure 5.1 (a) and Figure 5.1 (b), we find that the factors which were cheaper in A (toward extreme left of the curve) now fetch a higher price in A, a lower price in B, while the factors (towards extreme right) which were dearer in A have become cheaper and cheaper in B have become dearer. Ohlin also stated that, though, in this example a large number of factors are considered, only two countries are assumed. But this reasoning can easily be extended to several countries as well. On practical side, Ohlin contends that in the case of Australia, agricultural land would have been much cheaper than now, if no agricultural products were exported. Similarly, in America, forests would have been more costly than they are at present if there would have been no import of wood products from Canada and Scandinavia. He points out that the price of Australian land would have been raised and that of Europe lowered by the trade effect. Further, relative to the price of land, wages (labour price) have risen in Europe and declined in Australia due to an impact of international trade. It must be noted that, under certain limited conditions only, this tendency towards factor price equalisation will be carried to the point where factor prices are fully equalised. In other words, the factor price equalisation theorem is based on the following assumptions:

(i) There are quantitative differences of factors in different regions, but no qualitative difference. (ii) Production functions of different products are different, requiring different proportions of different factors in producing different goods. (iii) There is perfect competition in the commodity markets as well as in the factor markets in all the regions. (iv) There are no restrictions on trade, that is, free trade policy is followed by all the countries. (v) The consumers' preferences as well as the demand patterns and positions are unchanged. (vi) There are stable economic and fiscal policies in the participating nations. (vii) The transport cost element is ignored. (viii) Technological progress in different regions are identical. (ix) There are constant returns to scales in each region. (x) There is perfect mobility of factors. (xi) There is tendency towards complete specialisation. Under these assumptions only the theorem holds that free trade between countries tends to reduce the original factor price inequality, and a state of complete specialisation in effect leads to a complete factor price equality. However, complete factor price equality may be a theoretical possibility but it is hardly significant to be a practical phenomenon. Ohlin himself admits that a movement toward freer international trade might cause a partial international equalisation of factor prices. But a complete equalisation of factor prices will not occur for the following reasons: 1. There is the existence of transport cost in international trade. 2. There may be inter-country differences in the stages of technological advancement and managerial capacities. As such the production function for the same good might differ between regions, which will reduce the possibility of complete specialisation and in turn factor price equality. 3. There is unequal regional development in the economies of scale and the economies of agglomeration. This may tend to interrupt the tendency towards complete specialisation. 4. There are inter-country differences in tax structure, social objectives and economic policies. 5. There are inter-country differences in the buying habits of the people, consumers' demands, and marketing costs. 6. In actual life, even within a region, mobility of factors of production is imperfect due to many impediments and obstructions. This obviously restricts the feasibility of complete specialisation and thereby, commodity as well as factor price equalisation. 7. Perfect competition also does not exist in reality. Thus, prices of the same factors may widely differ between industries on account of their differing demand and absorptions in these industries where there is maladjustment of resources caused by monopolistic elements. Moreover, monopolistic

competition and discriminating monopolies tend to obstruct factor movements and the flow of trade which hinders the process of specialisation and factor-price equality. 8. Due to foreign exchange problem or other reasons sometimes when a country finds it impossible to meet its entire demand by improving a 'dear factor bounded product', it has to resort to domestic production as well. In this situation, there is no complete commodity specialisation, hence, there is no complete factor price equalisation. 9. Furthermore, factor units are not homogeneous even within a region. Thus, regions are not only quantitatively but also qualitatively differently endowed with different factors. This qualitative difference in factor units of different regions will account for differing factor prices even after the occurrence of trade. 10. According to Ohlin, if there is one country which has a world monopoly of a certain factor, trade will raise its price in this country due to extended derived demand, but it will not lower the price of this factor in other countries, as there is no supply of this factor elsewhere. So we cannot speak of factor-price equalisation theorem in such case. 11. Ohlin also mentions that if quite distinctive factors are in close competition when used in one industry to produce the same or a similar product while usually they are put to quite different uses, then trade will fail to equalise factor prices. In actual practice many articles are produced by means of widely different technical processes giving differing ratios of returns and factor earnings. 12. Complete factor price equalisation requires free trade. In practice all countries resort to some protection at least and restrict their trade by tariffs, quotas, licences, exchange control and many other devices. Ohlin thus, rightly concludes that the tendency of trade in equalising factor prices internationally has to be qualified in many respects. Especially, the difference in quality between productive factors in different nations, the wide differences in technical progress between countries, the economies of large-scale production causing decreasing costs, the differences in economic stability and tax structure, trade restrictions etc., and other impediments make it uncertain as to what extent trade can bring factor price equality in practice. In short, when the costs of transport and other impediments to trade are taken into account, a complete factor price equalisation is obviously impossible. It follows that prices of productive factors vary from one region to another even after the establishment of free international trade because, in practice, it can lead only to a partial factor price equalisation. In Kindleberger's opinion, since trade tends to raise the price of the abundant factor weakening the price of the scarce factor and brings about factor-price equalisation, this repercussion of trade on factor prices is greatly important, politically as well as economically, especially where the trade is based on differences in factor endowments.

In conclusion, we may note that complete factor-price equalisation is an impracticable phenomenon. On the contrary, sometimes factor prices may even move apart as trade takes place. This, however, does not imply that the factor-price equalisation theorem is totally useless. Though, it might not have any practical utility, it has theoretical significance in that it serves as a basis for explaining factor-price differentials actually observed in practice. It does provide a basis for the further analysis of forces affecting factor prices in international trade and for constructing some more realistic models of international economy.