Chapter 44: The Integrated World Equilibrium Diagram
Avinash Dixit Factor price equalization means that under certain conditions, unrestricted international trade in goods equalizes prices of factors across countries, even though the factors cannot move across borders so there are only separate national markets for them. When Victor Norman and I started our work on various generalizations of the 2-by-2 Heckscher-Ohlin-Samuelson model of trade, the dominant approach to the factor price equalization issue was ‘univalence’, namely whether the mapping from the prices of factors to the unit costs of goods was globally invertible. The mathematical conditions for this were stringent and abstruse, and relevant only in the case where the number of goods exactly equaled the number of factors. No one knows the exact number of either, but surely it is extremely unlikely that the two are equal. As Victor Norman remarked, what is really special about the 2-by-2 case is not that 2 is a small number, but that 2 = 2. The univalence approach had an even more basic flaw. It enabled us to find unique factor prices given the prices of goods. But where do these prices of goods come from? Under free trade, they come from the equilibrium conditions of the world markets for goods. Trade theory has always prided itself on being a showcase for general equilibrium theory. The study of factor price equalization should not disregard the fact that a trading equilibrium is a general equilibrium. This implies some restrictions on the prices of goods. We should look for solutions to the set...
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