Factor Price Equalization in Heckscher-Ohlin Model

Stephen E. Spear, Daniele Coen-Pirani and Sevin Yeltekin ()

No 2006-E77, GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: This paper investigates the likelihood of factor-price equalization under the simple assumptions of Heckscher-Ohlin Theory. Factor-price equalization is also directly related to whether countries specialize or not in the global market. A full-equilibrium in the world requires not only the equilibrium in the production side of the economy, but also the supply-demand equality in the world. However, once we obtain an equilibrium in the production side of the economy, it is always possible to define demand in a way to get supply-demand equality at any production side equilibrium amounts. Therefore, it is not possible to talk about factor-price equalization without specifying demand in the economy. Using L-P diagrams, the paper demonstrates how both factor-price equalization and non-equalization cases are possible when we look at only the production side of the economy. It is also demonstrated that the equilibrium possibilities will be much larger for factor-price equalization case if the number of commodities is more than the number of factors of production. However, the larger possibilities do not refer to different real equilibria, but only to indeterminacy in production. When demand is introduced in the economy and supply-demand equality constraints are respected, we see that factor-prices might or might not be equalized depending on factor endowments, production functions and demand. The paper demonstrates this by introducing a model with 2 countries, 2 factors of production, 3 goods and CES utility function. Finally, using comparative statistics on this simple model, the conditions under which the likelihood of factor-price equalization increases are determined.

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