Immobile Factors: Basic Assumptions
by Steven Suranovic ©1997-2004
Perfect Competition prevails in all markets.
The case of two countries is used to simplify the model analysis. Let one country be the US, the other France*. Note, anything related exclusively to France* in the model will be marked with an asterisk.
Two goods are produced by both countries. We assume a barter economy. This means that there is no money used to make transactions. Instead, for trade to occur, goods must be traded for other goods. Thus we need at least two goods in the model. Let the two produced goods be wine and cheese.
Two factors of production are used to produce wine and cheese. Wine production requires wine workers while cheese production requires cheese workers. Although each of these factors is labor, they are different types of labor since their productivities differ across industries.
Consumers maximize utility
Factor owners are the consumers of the goods. The factor owners have a well defined utility function defined over the two goods. Consumers maximize utility to allocate income between the two goods.
The immobile factors model is a general equilibrium model. The income earned by the factor is used to purchase the two goods. The industries' revenue in turn is used to pay for the factor services. The prices of outputs and the factor are chosen such that supply and demand are equalized in all markets simultaneously.
We will assume that aggregate demand is homothetic in this model. This implies that the marginal rate of substitution between the two goods is constant along a ray from the origin. We will assume further that aggregate demand is identical in both of the trading countries.
International Trade Theory and Policy Lecture Notes: ©1997-2004 Steven M. Suranovic