Showing papers on "Factor price published in 1970"

Price uncertainty, utility, and industry equilibrium in pure competition*

Abstract: THE NEOCLASSICAL THEORY of the firm assumes that the entrepreneur behaves as if his demand curve, production function, and factor costs are known with certainty. Although it is recognized that the firm may be uncertain about the form of these functions, the entrepreneur is assumed to compress his judgments about a function into a best estimate. He then behaves as if the best estimate represents the function with certainty. The formal consideration of uncertainty about the functions, however, can significantly qualify the results of neoclassical theory. The purpose of this article is to extend the traditional deterministic model of the firm to the situation in which the price for the firm's product is a random variable. The analysis of this situation is important not only 1Qecause of the generalization of the traditional model, but because it introduces additional considerations, such as attitudes toward risk, that may help to litter explain observed behavior. A number of authors 'have investigated various aspects of the static theory of the firm under demand uncertainty and their major results will be briefly discussed here. Their models can be differentiated by the competitiveness of the economic environment assumed, the nature of the demand uncertainty, and by the behavioral assumptions employed. The models of purely competitive firms will be discussed first and then models of firms in imperfect competition will be considered. Uncertainty is usually introduced into a model of pure competition by assuming that price is uncertain and that the firm can sell any quantity at the price that obtains in the market. Oi [15] assumed that the firm was able to observe price prior to determining output or equivalently that the firm could instantaneously adjust output. With this assumption and an objective of maximizing( expected profit the firm produces such that price and marginal cost are equated as in deterministic theory. Oi was concerned with the desirability of price uncertainty and demonstrated that expected profit exceeds the profit that would be obtained with a certain price which is equal to the expected price. He also demonstrated that the firm prefers increased variability of price in certain cases and extended the analysis to the case of a firm with nonlinear risk preferences.2 Nelson [13] presumed that the firm makes its output decision prior to ob

Factor Price Equalization in a Dynamic Economy

Abstract: Two of the most important propositions of the modern theory of international trade are extensions of the Heckscher-Ohlin analysis of comparative advantage: Free international trade completely equalizes factor prices (and thus ensures world Pareto optimality), and the removal of protective barriers decreases the return of the scarce factor in terms of both commodities and increases that of the abundant factor.' Both of these propositions were proved under seemingly general conditions, although in the context of a static model. But whether these results still hold in a dynamic economy has, almost without exception, gone uninvestigated in the literature.2 in a dynamic model, moreover, there is the additional question of whether international trade, even if it equalized rental rates on machines, would equalize rates of interest, in particular if the two countries had different rates of time preference. Recently, Samuelson (1965) showed that if there is nonspecialization (and the other assumptions of the Samuelson-HeckscherOhlin model are satisfied), then interest rates as well as rental rates are equalized. It has long been recognized, however, that if factor supplies are variable, specialization is much more likely to occur. Indeed, one of the principal reasons Ohlin (1933) did not argue for complete factor price equalization

The Aggregation of Heterogeneous Capital Goods and Various Trade Theorems

Abstract: Some authors, in working with the two-factor trade model, carefully specify that the factors of production in the model are labor and land. However, at some point in the development of a course in international trade theory, capital replaces land as the factor that cooperates with labor. The properties of the capital factor are often not specified. Most frequently it is implicitly given properties that are directly analogous to those of the factor previously identified as land. A physical unit of capital is identifiable. The quantity of capital can be measured, and this amount is independent of the factor prices ruling in the economy. The impression is also given that capital is the real value of machines and naturally productive resources. If the real value of machines is kept constant and a disturbance is introduced, the new equilibrium is attained when the composition of machines has been changed in accordance with the dictates of the new conditions. As long as capital is land or one type of machine, units can be identified and a total physical factor endowment can be calculated. However, if there are two different items classified as capital, a numeraire must be introduced in order for capital to be summed. If capital goods are valued at their reproduction cost, their value will be sensitive to changes in factor

International Trade in Inputs and Outputs

Abstract: In defending the twin assumptions that commodities can move freely among countries but primary factors are completely immobile internationally, trade theorists generally point out that without the factor-immobility assumption the distinction between international trade theory and domestic production and exchange theory disappears.' However, since the regional pattern of trade as well as the geographic distribution of productive factors becomes indeterminate when it is assumed that both goods and factors are perfectly mobile within a country, domestic production and exchange theorists usually assume all economic activity takes place at one point in space. Consequently, factor movements and their interrelationships with commodity flows have not been analyzed within the mainstreams of either international trade theory or domestic production and exchange theory. Instead, the subject has become a subsidiary topic of economic theorystudied mainly by location theorists, by economic historians, and, more recently, by economists interested in development theory. The leading trade economist who has tried to change the typical practice of separating the treatment of commodity and factor flows is, of course, Bertil Ohlin.2 As he states in the Preface, a major purpose of his treatise is: "To analyze the domestic and international movements of factors of production, and particularly their relation to commodity movements."3 Although Ohlin's work is rich in insights on this subject, the general impact of his work has, ironically, been to reinforce the traditional approach of trade writers. For although Ohlin stressed that labor and capital are neither completely mobile or immobile internationally, he in effect assumed in his simplified trade model that knowledge was completely mobile and, therefore, that production functions were everywhere the same.4 It then remained for Samuelson to show that, by adding a few seemingly reasonable assumptions, factor prices become equalized through trade.5 Despite Samuelson's warning that the actual disparity in factor prices among countries meant that these assumptions were not so innocuous after all, the factor-price equalization model has tended to become the cornerstone of international trade theory. And, since the same world production possibilities are attainable in this model with commodity trade alone as with commodity plus factor trade, the tradition of ignoring factor movements has been further justified. Recent events, especially in connection with the operations of international firms, have, however, made it increasingly inappropriate to ignore the interrelations between output and input flows. Trade economists could in the past partly justify their position on the grounds that different decision-making units were usually involved in commodity and factor flows and that in the nineteenth century a large share of factor flows were directed at the production of noninternationally traded services, e.g., canal and railway services, or of commodities effectively unavailable in the developed countries, e.g., tropical products and certain minerals. But, today we frequently observe the phenomenon of an international firm weighing the alternatives of producing a particular commodity in one country and then shipping it to the market of another country or transferring technology and productive factors to this latter country and manufacturing the product there. The possibility of various patterns of trade in intermediate inputs makes the set of feasible alternatives facing the international firm even more complex. In order to understand better the nature of current international commodity and factor flows and to be able to deal more adequately with the policy issues they raise, we should return to Ohlin's broad vision of studying these flows simultaneously. It is also important that we consider the institutional form that these flows take. Fortu1 See, for example, G. Haberler, The Theory of International Trade (London: William Hodge, 1936), pp. 4-5. 2 Bertil Ohlin, Interregional and International Tr-ade (Harvard Univ. Press, 1952). 3 Op. cit., p. viii. 4 0p. cit., p. 557. ' Paul A. Samuelson, "International Trade and Equalization of Factor Prices," Econ. J., June, 1948.

The Heckscher-Ohlin Theory of Factor Price Equalization and the Indeterminacy in International Specialization

Abstract: GIVEN THE PRODUCTION TECHNOLOGY, we may expect that the pattern of production and trade of a country would be determined by factor endowments and demand patterns in the Heckscher-Ohlin model. Imagine, however, a kind of perfect Heckscher-Ohlin world where the factor prices are equalized in every country. Suppose we are asked what the pattern of production and trade of a country would be, given the data on production technology, factor endowments and demand patterns of every country. If it is a world where the number of goods (n) exceeds the number of factors (in), we cannot say anything definite about the production and trade pattern of a country, i.e., the precise degree of international specialization is indeterminate. When Wt < V, the factor endowments and the demand patterns of each individual country have no formal places in the Heckscher-Ohlin theory of factor price equalization itself to determine the precise pattern of production and trade of each country. Furthermore, no one has yet rigorously explored the possible implications of the factor price equalization theorem specifically with respect to the determination of patterns of production and trade of each country. The main purpose of this paper is to derive a theoretical framework which can specify the static global equilibrium pattern of specialization when n exceeds mn on the basis of the Heckscher-Ohlin theory of factor price equalization. In order to specify the production and trade pattern of each country, we will introduce a simple assumption which seems reasonably realistic that, if the total value of outputs is the same, each country has a tendency to minimize international transaction activities. With this assumption it will be shown that we can eliminate the uncertainty concerning the precise pattern of production and trade of each country, and hence we can deduce a theoretical framework to determine the pattern of production and trade in multisectoral economy from the factor price equalization theorem.

On Factor Price Equalization When Commodities Outnumber Factors: A Note

Abstract: In a recent article in this journal, Professor H. G. Johnson has been able to show that an earlier finding by Dr. Land that factor prices may diverge with trade violates a consistency condition relating the changes in production resulting from the introduction of free trade and the requirement of full employment of fixed factor supplies.2 In his paper, Professor Johnson is also concerned with the question considered by Land of whether increasing the number of commodities increases or reduces the probability of factor price equalization. He concludes that "contrary to Dr. Land's general position the larger the number of goods relative to the number of factors the more likely is free trade to lead to factor price equalization" (p. 288). This Note contends that both Johnson's and Land's arguments on this latter question are not valid. Following Land and Johnson, a two-factor (capital, K, and labour, L), three commodity (X, Yand Z) and two-country (I and II) model is used. It is assumed that the production functions fulfil the strong Samuelson factor-intensity assumption, i.e., X, Y and Z are characterized by decreasing capital-to-labour input ratios for all factor price ratios (price of labour in terms of capital). Johnson's argument is illustrated in Figure 1, which corresponds to Figure 2 in his paper. Neglecting for the moment commodity Y, the possibility of factor price equalization may be defined for the two-good case. "The upper part of the diagram shows the technological relationship between the capital-labour ratios in the two industries and the factor-price ratio .. .; the lower part shows the technological relationship between the factor-price ratio and the relative price (cost) of Z in terms of X, for arbitrarily chosen units of Z and X, the price of Z rising as the relative price of labour rises because Z is labour-intensive relative to X" (p. 283). With fixed factor endowments, the capital-labour endowment ratios in the two countries determine a range of factor prices consistent with production of X and Z. For country I, this range is wlw3 and for country II it is w2w4. If the factor endowment ratios of the two countries are close enough so that there is a range of overlap in the feasible factor prices as in Figure 1, then there is a possibility of factor price equalization. If free trade leads to a

The Effects of Price Supports on Output and Factor Prices in Agriculture

Abstract: The model developed by Floyd (1965) to show the effects of farm price supports on the returns to the factors in farming is based on widely accepted assumptions and could be applied to a wide range of economic problems. However, the model is overdetermined, and Floyd's solutions are incorrect. Floyd attempted to solve his model with nominal prices, thereby introducing "money illusion" in a set of relationships which may be depicted by a two-space isoquant map where the slope of a linear budget constraint is a relative (real) price. I will demonstrate that the model is overdetermined by solving the five-equation system with four of the equations. I then briefly discuss the inconsistencies in Floyd's solutions. My alternative model reduces the elasticities Floyd sought to the reciprocal of the relative factor shares and allows estimates of the long-run supply of farm output using the parameters from Floyd's article.

Nonpecuniary Rewards and the Aggregate Production Fuction

Abstract: T has long been recognized that the provision of nonpecuniary rewards to a factor of production creates a corresponding reduction in the observed market price of the factor. But the effect of the provision of nonpecuniary rewards on marginal products and thus on the relationship between marginal products and observed factor prices, has long remained an open, albeit unpressing, question in economic theory. This neglected question has recently grown in importance as several influential papers concerned with the estimation of production functions (e.g., Solow [ 7 ] and ACMS [2]) have been crucially based on the identification of marginal products with observed factor prices. Section I of this paper contains a generalization of the usual theory of the firm which allows for (1) joint production in a general form and (2) the existence of outputs which are not separately marketed. Differences between private marginal products and competitive factor prices, hereafter called "discrepancies," are seen to be possible when and only when some of the firm's outputs are sold or evaluated in factor markets as nonpecuniary rewards. A factor's observed price is seen to equal its "net" marginal product, its marginal product plus the reduction in payments to other factors made possible by a unit addition of the factor. Since the latter part of the net marginal product is not a derivative of an observed production function, the following empirical proposition becomes obvious: A factor's marginal product cannot be identified with its observed competitive factor price; nor can the magnitude or direction of the actual discrepancy be casually specified. This proposition immediately implies the existence of a fallacy, probably a crippling fallacy, in the modern approach to the estimation of production functions. Section II, which builds on the analysis of discrepancies in section I, contains the key result that any discrepancy can be considered a "disaggregation bias"that when all firms are combined to form a competitively determined industry production function and all inputs are suitably grouped to form a single input index, the marginal product of the input index is equal to its average cost! To establish this, it is shown that for given relative output prices and given conventions on the indirect marketing of outputs, an ordinary industry production function generally exists in neoclassical, competitive equilibrium, that this aggregate production function is linearly homogeneous, and that observed factor payments exhaust the product; yet there are, in general, no equalities between factor prices and marginal products. This surprising result is used to show that the identification of the aggregate marginal product of a factor with its observed factor cost can be justified on neoclassical grounds only when the "factor" is a single index of all of the various factors of production. Thus, while the modern techniques of studying technology based upon identifying marginal products of individual factors with observed factor prices are theoretically groundless in the presence of nonpecuniary rewards, the techniques of testing for scale economies and measuring technical change introduced by CobbDouglas and by Abramovitz [ 1 ] and Kendrick [5] are valid applications of neoclassical theory under suitable treatments of the relevant input indices. Also rationalized is a technique devised by the present author [8] of estimating both the degree of aggregate returns to scale and the annual rate of technical change with a single index of all inputs.1 * This work was supported by the Institute of Government and Public Affairs at the University of California at Los Angeles and by the National Science Foundation under Grant G-16239. The author benefited substantially from a discussion with Karl Brunner and from the comments by a Referee on an earlier draft. 1 The empirical results of [8] strongly confirm a hypothesis suggested by the present paper; viz., that there is a great deal of inequality between the marginal products and prices of separate inputs but there is an equality between