By Robert C. Feenstra
Modern and extremely transparent presentation of the mainstream concept of overseas exchange.
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Additional info for Advanced International Trade: Theory and Evidence
Following Leamer (1980), we define capital to be abundant i w i w relative to labor in country i if K /K > L /L . 1) implies that the capital/labor ratio embodied in production for country i exceeds the capital/labor ratio embodied in consumption: i i i i K /L > (K – Fki )/( L – Fli ) . 2), we have K = (K – Fki )/ s and L = (L – Fli )/ s . It follows that i w i i i i i i w i i i i w i w K /K = s K /(K – Fki ) and L /L = s L /(L – Fli ). 3) . QED Feenstra, Advanced International Trade 2-13 i i To interpet this result, note that K and L are simply the endowments of capital and labor, or alternatively, the capital and labor embodied in production.
A If p is also the autarky price in the foreign country, then production must occur at the a tangency between the price line with slope p and the foreign PPF, or at point B’. Notice that from the Rybcynzski Theorem, point B’ must lie above and to the left of point A: the higher capital endowment abroad leads to more of good 2 and less of good 1. The price line through point B’ acts like a budget constraint for the representative consumer in the foreign country, so that the consumer chooses the highest indifference curve on this price line.
The slope of the line between V and AD measures the ratio of factor prices. The theorem of Leamer (1980) states that if country 1 is labor-abundant, as illustrated, then the capital/labor ratio embodied in consumption must exceed the capital/labor ratio i embodied in production. That is, since the consumption point AD must lie on the diagonal, it is i necessary above the endowment point V . While this is graphically obvious, note that it does not depend in any way on whether trade is balanced or not.