International Trade Theory and Policy
by Steven M. Suranovic
Trade 60-5
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The Stolper-Samuelson TheoremThe Stolper-Samuelson theorem demonstrates how changes in output prices affect the prices of the factors when positive production and zero economic profit are maintained in each industry . It is useful in analyzing the effects on factor income, either when countries move from autarky to free trade or when tariffs or other government regulations are imposed within the context of a H-O model. Due to the assumption of perfect competition in all markets, if production occurs in an industry, then economic profit is driven to zero. The zero profit conditions in each industry imply,
where PS and PC are the prices of steel and clothing respectively, w is the wage paid to labor and
r is the rental rate on capital. Note that The same logic is used to justify the zero profit condition in the clothing industry. We imagine that firms treat prices exogenously since any one firm is too small to affect the price in its market. Since the factor output ratios are also fixed, wages and rentals remain as the two unknowns. In the adjoining diagram we plot the two zero-profit conditions in wage-rental space.
Similarly the set of all wage-rental rate combinations which generate
zero profit in the clothing industry at price PC
is given by the steeper red line. All wage-rental combinations above the
line, as at points B and D, generate negative profit, while wage-rental
combinations below the line, as at A and C, generate positive profit.
The slope of the steeper red line is The only wage-rental combination that can simultaneously support zero profit in both industries is found at the intersection of the two zero-profit lines - point E. This point represents the equilibrium wage and rental rates that would arise in an H-O model when the price of steel is PS and the price of clothing is PC.
If the price of clothing had risen, the zero-profit line for clothing would have shifted right causing an increase in the equilibrium wage rate and a decrease in the rental rate. Thus an increase in the price of clothing causes an increase in the payment to the factor used intensively in clothing production (labor) and a decrease in the payment to the other factor (capital). This gives us the Stolper-Samuelson theorem: An increase in the price of a good will cause an increase in the price of the factor used intensively in that industry and a decrease in the price of the other factor.
International Trade Theory and Policy - Chapter 60-5: Last Updated on 7/31/06 |