Factor Endowment Theory

1. Factor Endowment Theory (Heckscher-Ohlin Model)

2. Eli Filip Heckscher was a Swedish political economist and economic historian. He studied at university in Uppsala and Gothenburg, completing his PhD in Uppsala in 1907. He was professor of Political Economy and Statistics at the Stockholm School of Economics from 1909 until 1929, when he exchanged that chair for a research professorship in economic history, finally retiring as emeritus professor in 1945. Eli Filip Heckscher (1879-1952) Heckscher worked so hard in his life, till 1949, he had published 1148 books and articles, among which may be mentioned his study of Mercantilism, translated into several languages. In 1919, Heckscher published a research paper in Swedish The Effect of Foreign Trade on the Distribution of Income, in which he introduced basic ideas about how to put trade on the basis of a country’s factor endowment.

3. Bertile Ohlin was born into an upper-middle class family in a village in the South of Sweden. He got his B.A. from Lund University 1917, M.A. from Harvard in 1923, and Ph.D from Stockholm University in 1924. In 1925 Ohlin became a professor at the University of Copenhagen. In 1930 he succeeded Eli Heckscher, his teacher, as a professor of economics, at the Stockholm School of Economics. Bertil Ohlin (1899~1979) Ohlin’s results were firstly published in his doctoral dissertation in Swedish, Theory of Trade in 1924, and afterward, far more fully in his well known book in the Harvard Economic Series, Interregional and International Trade in 1933. Jointly won Nobel prize for economics with James Edward Meade in 1977. In this Ohlin built an economic theory of international trade from earlier work by Heckscher and his own doctoral thesis. It is now known as the Heckscher-Ohlin Model, one of the standard model economists use to debate trade theory.

4. For thirty years from 1919 till 1949 few scholars in the academic circle of international trade knew Eli Hechscher but most of them would be very much familiar with a famous name Bertil Ohlin. People once mentioned the theory of factor endowment as “Ohlin model”. • Heckscher and his paper did not popularize at least for two reasons. • At first the paper published in 1919 when the World War One just ended. The interests of the major powers in the world at that time were not on the issues of trade theory. • Secondly, Heckscher had his academic activities mostly in Sweden and the paper was published in Swedish. But we know that Swedish is not as wide spread as English. • Therefore, when Ohlin was well known and the theory was once termed as Ohlin model people seldom knew that it was Heckscher who was the originator of factor endowment theory. • Heckscher’s article was first widely introduced to the academic circle in 1949 when American Economic Association included his famous paper in The Readings in the Theory of International Trade published in English with the contributive helps of Professor Svend Laursen and his wife who had undertaken the trouble of translating Swedish text of the paper into a proficient English.

5. Heckscher’s Illustration on Factor Endowment Theory

6. Two Theoretical Assumptions of Heckscher 坚持以上两个假定，从物物交换的本质属性可知，贸易可以带来消费满足的最大化，或者说，贸易将使国民收入最大化。 If one initially employs all of the above assumptions it follows from the nature of barter that trade will create the maximum satisfaction of wants or the maximum national income . Heckscher established his theory on two assumptions: First, changes induced by foreign trade in the nature of the factors of production (“dynamic” changes) are completely disregarded. Thus the quantity of factors of production within a country is given; Second, no attention is paid to the advantages one particular country may achieve by means of protection. That is to say he only discussed problem of international trade in the framework of free trade.

7. Source of Trade Benefit Such a gain in total satisfaction arises whenever the law of “comparative costs” operates (贸易的收益源于比较优势), i.e., whenever a want is more easily satisfied in an indirect way, through the production of another commodity which can be exchanged for the commodity desired, than by producing the latter directly. It’s so obvious that trade on the basis of comparative cost advantages is the real source of trade benefit. In order maximize a country’s national income the country must be active in trade rather to meet all of consumption wants of its residents directly. By trading with the other country it would be cheaper for the home country to indirectly meet the home demand for particular goods by importing such goods from abroad, which could be paid with its own exportable goods, rather than directly meet the demand by producing import substitution goods at home.

8. From Where Derives Comparative Advantages No different factor endowment no differences in relative price of production factors and no different comparative costs of products consequently no trade between different countries. It has been strongly suggested that different factor endowment between different countries must be the basic pre-requisite for trade between them. Besides that there must be different proportions of production factors in producing different goods. Heckscher mentioned the former asa necessary condition for a difference in comparative costs and consequently for international trade and he mentioned the latter asa further indispensable condition. From these two important conditions comparative advantages of particular country could be derived.

9. How did Heckscher illustrate his ideas? The prerequisites for initiating international trade may thus be summarized as different relative scarcity, i.e., different relative prices of the factors of production in the exchanging countries, as well as different proportions between the factors of production in different commodities. A difference in the relative scarcity of the factors of production between one country and another is thus a necessary condition for a difference in comparative costs and consequently for international trade. A further indispensable condition is that the proportions in which the factors of production are combined shall not be the same for one commodity as for another. In the absence of this second condition, the price of one commodity, compared with the price of another would remain the same in all countries regardless of differences in relative factor prices.

10. Ohlin’s Illustration on Factor Endowment Theory

11. How does a country differentiate from another? 尽管各国之间的确存在方方面面的差异，但一国所以区别于他国，最关键的是他们各自拥有不同的生产要素自然秉赋。 • There should be some kind of natural distinction between regions. • The principal criterion used to differentiate one region from another is its endowment with factors of production. • Hence, regions have different factor endowments, while the factors within a region are essentially similar.

12. “Varying Ability” and “Advantages of Specialization” 什么是导致劳动分工的原因？为什么人们之间要相互交换？为什么劳动分工会使总体生产效率提高？究其原因无非是两点：一为每个人的能力各异，二为生产专业化带来的优势。 What are the causes of division of labor in general? Why do individuals trade with each other, instead of each one producing his own requirements? Why does division of labor increase the total efficiency of production? The reasons may be grouped under two headings: “varying ability” and “advantages of specialization”.

13. First of all, some individuals have greater ability for certain tasks than others. Varying natural aptitudes make one more fit to be an engineer, another better suited for the work of physician or a lawyer. Some people take greater interest in gardening than in other occupations, and hence probably make better gardeners than others. Examples could be multiplied. Second, even if all individuals had exactly the same natural abilities, it would be still be advantageous to have specialization in one or a small number of occupations. In this way much greater skill can be acquired than if everyone produced everything for himself. Furthermore, the workman who constantly attends to one task wastes no time changing over from one occupation to another. In short, there results an increase in skill and a saving of time when each individual is occupied in the production of a large number of one particular article instead of cooperating in the production of a small quantity of many different articles.

14. Sources of Comparative Advantages It is the proportion of the factors in a region that determines its fitness for specific industry. 正是某一地区拥有的生产要素的比例决定了该地区适合于从事某一特定产业的生产。 Turning from individuals to regions, one finds that the two regions might be quite differently endowed with facilities for the production of various articles. One reason is that they are differently supplied with productive factors. One region may have plenty of iron and coal but little land for wheat-growing, while another has plenty of wheat-growing land but a scanty supply of mineral resources; clearly the former is better adapt to iron production and less well adapt to wheat-growing than the latter.

15. Australia vs Great Britain Australia has more agricultural land but less labor, and capital, and mines than Great Britain; consequently, Australia is better adapted to the production of goods that require great quantities of agricultural land, whereas Great Britain has an advantage in the production of goods requiring considerable quantities of other factors.

16. Nature of a country’s factor endowment and its Comparative Advantages Relatively abundant factor → extensive method of employment → relatively low price of this factor → price of the goods requiring relatively large proportions of the abundant factor would be relatively low. Relatively scarce factor → intensive method of employment →relatively high price of this factor → price of the goods requiring relatively large proportions of the scarce factor would be relatively high. 一国的要素禀赋状况决定要素的使用方式，决定要素的价格，决定商品的价格，进而决定一国在贸易中在特定商品的生产与出口上享受到的价格竞争优势。 The nature of a country’s factor endowment determines the method of production and then the relative price of production factors and consequently the relative costs of products and at last the comparative advantages of a particular country.

17. “In brief, each region is best equipped to produce the goods that require large proportions of the factors relatively abundant there; it is least fit to produce goods that require large proportions of factors existing within its borders in small quantities or not at all. Clearly, this is the cause of interregional trade, just as varying individual abilities is cause of individual exchanges”. “一个国家最适合于生产需要更大比例地使用该国拥有的相对丰裕的要素的那些商品，最不适宜于生产需要更大比例地使用该国国内拥有量最小或完全不拥有的要素的那些商品。显然，这就是国际贸易的原因。不同的人由于能力各异相互交换一样。”

18. Case of Australia kangaroo Australia has an abundant supply of agricultural land but a scanty population. Land is cheap and wages are high in comparison with most other countries; therefore, production of goods that require vast areas of land but little labor is cheap. This is the case with wool, for example. Sheep-raising requires great areas of land but little labor, and the shearing is a relatively simple process; hence, wool can be produced at a lower cost than in countries where land is expensive, even if wages in the other countries are somewhat lower than in Australia. Similarly, regions with an abundant supply of labor, technically trained as well as unskilled, and of capital will find it profitable to specialize in manufactures, for labor is cheaper in such regions than in Australia. rangeland

19. Brief Summary The conclusion follows that “each region has an advantage in production of commodities into which enter considerable amounts of factors abundant and cheap in that region “每一个国家在密集地使用该国丰裕而价格低廉的要素的那些商品的生产上具有比较优势”。 Countries differ in their relative stocks of the different factors of production, these differential factor supplies influence the costs of producing particular goods. Differences in production costs lead to the comparative advantages of a country in international trade. A country with an abundant supply of capital and little labor, and therefore has a comparative advantage in and exports such capital-intensive goods.

20. Prominent Characteristics of the Theory Factor Endowment Theory of Heckscher and Ohlin has a prominent characteristic which obviously separate itself from trade theory so far of the older generations of economists.

21. Clearing off the Labor Value Theory Marxist political economy revealed the law of capital accumulation and became an ideological weapon of proletarian to fight against the capitalist exploitation. It is necessary for the so-called main trend economics to eliminate influences of Marxism. At first, the prominent characteristics of factor endowment theory is to clear off the labor value theory in analysis of the basis of trade. This development represents the tendency of vulgarization of economics in field of trade theory. Ultimately to treat living labor as only one of the factors just like capital and the other materials is hard to be understood as a progress. Where could we see the human rights?

22. Lay Comparative Advantages on a New Foundation The arduous task of Heckscher and Ohlin is to establish a real foundation for comparative advantages. How did they do that? They both agreed that mutually beneficiary trade comes from the respective comparative advantages of the trade partners. But they only took comparative advantages as an existing prerequisite. At the mention of sources of comparative advantages they argued that they could be only derived from the naturally constituted factor endowment, the Gifts of the Nature（上帝的恩赐）.

23. Some Comments on Factor Endowment Theory Factor endowment theory breaks away from the classical labor value theory and tries to explain the reason of international trade in an entirely new way. Heckscher-Ohlin theory holds that comparative advantages enjoyed by different countries are the pre-requisite of trade. These comparative advantages, however, do not come from the relative differences in labor inputs of production as the classical economists described. It is the differences in a country’s production factor endowment that determines the production costs of different countries and thus their respective comparative advantages in international trade.

24. That is to say it is factor endowment theory not labor value theory that functions as the foundation for international trade. This implies that comparative advantages and thus international trade do not related with labor at all. The very important comparative advantages are only the gifts of the nature. The basis of trade says good-bye to the labor value theory. This sort of theoretical development suits the need of bourgeois economics to negate the labor value theory since the theory functioned as the theoretical basis of Karl Marx’s political economy theory, which concluded the ending of the capitalist system and springing up of the communist system.

25. Theoretical Position of H-O Theory Since Heckscher and Ohlin opened up a new path and established a so-called reasonable theoretical approach of explaining and analyzing issues of international trade their theory had been widely accepted in the academic circles in the western world and had taken the position ofthe orthodox or the main trend of trade theory.(正统的或主流的国际贸易理论) Therefore, factor endowment theorycould be appropriately evaluated as a theoretic milestone in development of trade theory. Consequently, it has become the important theoretical origin of the so-called new trade theories developed in the past several decades.

26. The H-O-S Model The basic idea of factor endowment theory has been much refined and explored in the past several decades, in particular in a most famous series of papers by Paul Samuelson, W. Stolper, T. Rybczynski, and so on. Particularly, P. Samuelson published International Trade and the Equalization of Factor Prices (1948) and International Factor-Price Equalization Once Again(1949), the latterhad been included in Readings in International Economics (1968) edited by American Economic Association. Samuelson systematically proved the basic principle of factor endowment theory by a rigorous mathematical approach and introduced his contributive ideas about the theory. Therefore, factor endowment theory is sometimes known as Heckscher-Ohlin-Samuelson Model or “H-O-S Model”

27. Several Theoretical Assumptions of the Theory The extended trade model Constant supply of productive factors Countries differ from each other only in factor endowment No technical progress and no changes of returns in scale

28. The extended trade model That is the so-called “two country-two factor-two good model” ( 2×2×2 model ). The model could be used to illustrate trade between the two countries when they produce two commodities by using two sorts of production factors. It holds that the two sorts of production factors and the two commodities are assumed to be homogeneous, respectively. That is to say no attention would be put on the influences of different qualities of the production factors and goods produced. The two trade partners would be assumed differently endowed with production factors while the two goods would be assumed with different factor intensities. In addition trade would be assumed to be executed under the barter trade system. If we define the two sorts of factors as capital and labor, in this model, it is assumed that one country endows relatively abundant labor but relatively scant capital while the other country has a relatively abundant stock of capital but labor is of relative scarcity. Further more, one commodity is assumed to be labor-intensive while the other commodity capital-intensive. At last, barter trade would be carried out. No money used in trade for simplifying the analysis.

29. Constant supply of production factors That implies the variations in a country’s natural endowment of production factors would be disregarded. In addition, factors of production are internationally completely immobile but intra-nationally freely mobile. With this assumption the unique factor price would be reached in one country’s domestic market for production factors. Because each country’s production factors and commodity market are assumed perfectly competitive the total amount of all sorts of factors of production could be fully employed. That means the two countries can both realize one of the macroeconomic goals, full employment of production factors.

30. Countries differ from each other only in factor endowment The two countries are as the same as each other in almost every respect except their factor endowment. It follows that the same production techniques would be applied to produce the two commodities. Or equivalently speaking, the two countries have the same production functions of the two commodities. Furthermore, propensity to consume in one country is as the same as that in the other country. The same propensity to consume implies that consumption proportion of the two goods does not differ in the two countries when prices of the two commodities are given.

31. No technical progress and no changes of returns in scale Constant Production techniques means the impact of technical progress on trade patterns will not be considered. Thus people can analyze respective comparative advantages of different countries exclusively derived from differences in factor endowments and trade patterns on the basis of such differences. The assumption of that returns in scale do not change in line with variations in production scale indicates that certain percentage of changes in input of production factors will lead to the same percentage of changes in the output produced. That means No diminishing returns of scale.

32. Brief summary of the assumptions From the above theoretical assumptions of the theory we can easily see that the essential difference between the theory and other trade theories is that it inserts a new element into its trade model. That is factor of production. The former “2×2 model” has been changed into the so-called “2×2×2 model”. By adding this element into trade model Heckscher and Ohlin successfully laid the basis of trade on different factor endowments of the countries participating international exchanges. In this “2×2×2 model”, for instance the two countries, A and B, are producing and exchanging two goods, F and C, by using two sorts of production factors, L and K. In this model, if we say country A has a relatively abundant supply of labor and a relatively scant endowment of capital. It is equivalent to say that country B is relatively rich in capital endowment and it is relatively scantly supplied with labor. Similarly, in this model if Good F is labor-intensive that implies Good C is capital-intensive.

33. Two important theoretical problems To correctly understand the essentialities of factor endowment theory two important theoretical problems must be resolved in advance. Problem One: How to define the factor abundance or scarcity of a country?（如何确定一国何种要素相对丰裕，何种要素相对稀缺？） Problem Two: How to define factor intensities of different goods? （如何确定不同商品的要素密集性质？）

34. How to define the factor abundance or scarcity of a country? Physical definition（实物定义）： A country is relatively labor abundant and capital scarce because , in this country than in its trade partner, more labor are allocated with certain amount of capital, or less capital are allocated with certain quantity of labor. Conversely, if relatively more capital could be allocated with certain quantity of labor, or less labor are allocated with certain amount of capital, in a country than in its trade partner, this country is a capital abundant and labor scarce country. It is very obvious that the so-called physical definition is actually a comparison between the capital/labor ratios, or the labor/capital ratios of the two countries.

35. The K/L ratio is a very important criterion of defining basic nature of a country’s factor endowment. Let’s use K and L stands respectively for capital and labor. In a two-country two-factor and two-good model, ∵( K/L ) a ＜ ( K/L ) b , or ( L/K ) a ＞ ( L/K ) b ∴Country A is a labor abundant and a capital scarce country relative to Country B. Or equivalently, Country B is a capital abundant and a labor scarce country relative to Country A.

36. Economic definition（经济定义）： Sometimes, economic definition can also be termed as price definition（价格定义）. As we know factor endowment of a country determines the techniques to use the factors of production, extensive or intensive. Consequently, factor prices will be much different between the different countries with different factor endowment. In the trade model price of labor will be relatively low while price of capital relatively high in a labor abundant and capital scarce country. In the other country, the labor scarce and capital abundant one, price of labor will be relatively high while price of capital relatively low.

37. If we use I and W for price of capital, interest, and price of labor, wage rate, respectively, we could have another definition of a country’s factor endowment. That is the ratio between prices of the two sorts of factors (for simplicity, we use the term factor price ratio, FPR). That implies the so-called economic definition is actually a comparison between different FPRs in different countries. In a two-country two-factor and two-good model, ∵( W/I ) a ＜ ( W/I ) b , or ( I/W ) a ＞ ( I/W ) b ∴Country A is a labor abundant and a capital scarce country relative to Country B. Or equ8valently, Country B is a capital abundant and a labor scarce country relative to Country A.

38. Problem Two: How to define factor intensities of different goods? The basic assumption of homogeneous production techniques in the two countries holds that the two countries produce the two kinds of goods, F and C, in particular production functions. It is supposed that respective production functions of Good F and Good C are as the followings: F = f ( 8K, 4L ), while C = f ( 6K, 2L ) Or equivalently, the two countries are using the same production techniques to produce the two goods and factor proportions in production of Good F and Good C are as the followings: 1F = 8K + 4L (8 units of K and 4 units of L should be employed to produce 1 unit of Good F) 1C = 6K + 2L (6 units of K and 2 units of L should be employed to produce 1 unit of Good C)

39. From the above production functions it is obvious that for producing one unit of Good F more capital and more labor should be employed than to produce one unit of Good C. But we can say nothing about factor intensities of Good F and Good C only by comparing the absolute quantities of K and L in producing certain amount of them. Otherwise, we could fall into a theoretical paradox. However, if we compare therelative factor inputs, in other words factor proportions of production functions, that is how to combine the two factors in production process we can find out that proportions of factor employment or relative ratio of factor input in producing Good F clearly differs from that in Good C.

40. ﹤ ｝ Good F is relatively labor intensive Good C is relatively Capital intensive. ﹥ In producing 1 unit of Good F, 2K are equipped for 1L, in other words 1L is equipped with 2K. In production process of Good C this number is 3. Three units of capital must be allocated for 1 unit of labor. That means more K should be allocated for certain labor input in producing C than F. Equivalently, in producing 1F, 1/2 L used for 1K, in other words for using 1K a half L must be employed with the given production technique. While in producing 1C, for 1K, 1/3 labor is enough. Consequently, we say Good F is a L-intensive good relative to Good C while Good C is a K-intensive good relative to Good F. Therefore, comparison of relative ratios of factor input in producing different goods serves as the only definition of factor intensity of particular commodity.

41. Theorems of the Factor Endowment Theory Heckscher-Ohlin Theorem Basic Theorems Factor Price Equalization Theorem Factor Endowment Theory Stolper-Samuelson Theorem Extensive Theorems RybczynskiTheorem The factor endowment theory has four theorems. They are two basic theorems and the other two extensive theorems.

42. Heckscher-Ohlin Theorem（赫克歇尔——俄林命题） Heckscher-Ohlin Theorem can be summarized as the followings: Comparative advantages of different countries serve as the basis of trade. Such comparative advantages come from the differences in their factor endowments. Therefore, different factor endowments among countries are the real cause of international trade. Consequently, a country has its comparative advantage in production of that good in which its relatively abundant factor is relatively intensively used. That is to say a country with a relatively abundant labor endowment and a relatively scarce capital endowment, thus its W/I ratios is relatively low, has comparative advantages in production of L-intensive good. Meanwhile, a country with a relatively abundant capital endowment and a relatively scarce labor, thus its W/I ratios is relatively high, has its comparative advantages in production of K-intensive good.

43. The respective comparative advantages determine production and trade structures of the two countries. In accordance with their respective comparative advantages the former should concentrate its productive factors on production of L-intensive goods and export these goods to exchange for K-intensive goods from the latter. Conversely, for the same token, the latter should concentrate its productive factors on production of K-intensive goods and export these goods to exchange for L-intensive goods from the former. By doing so the two countries can bring their respective comparative advantages into a full play and obtain trade benefits.

44. Factor Price equalization theorem（要素价格均等化命题） Factor price equalization theorem illustrates the function of price mechanism in the case of international trade. In a 2×2×2 model, according to Heckscher-Ohlin theorem, a L-abundant country has a relatively lower W/I ratio and thus it must export L-intensive goods and import K-intensive goods. Otherwise the country’s comparative advantages could not be brought into full play and the country could not enjoy economic benefit from free trade. Price equalization theorem can be summarized as the followings: A perfectly free trade between two countries will lead to a tendency of equalization of factor prices in them. If the two countries both practice a incomplete international specialization of production (实行不完全国际分工), i.e. they are both producing the two sorts of goods, the ultimate result of free trade must be an exact equalization of factor prices in the two countries. Such an equalization of factor prices could substitute, to some extent, functions of mobilization of factors of production between the two countries.

45. Taking specific assumptions, trade will cause changes in factor prices in factor market. (W/I)b Wa increase while Ia decreases. (W/I)a rises Trade based on factor endowment (W/I)i Wb decreass while Ib increases. (W/I)b falls (W/I)a At the same time, however, assumptions are held that factor endowments of the two countries are constant indicating the aggregate supply of production factors would not change. It is also assumed that price of production factors must be determined by supply-demand relations in a perfectly competitive factor market. Therefore, in line with trade, L-abundant Country A’s domestic production scale of L-intensive goods increases and that of K-intensive goods decreases. Thus in its domestic factor market demand for L will be relatively larger while demand for K will be relatively smaller. Taking a constant factor supply price of labor tends to increase and price of capital tends to fall. The opposite development will be in Country B.

46. Another function of trade will lead to such relative variations in factor prices in the two countries. In addition, when this L-abundant country exports its L-intensive goods and imports K-intensive goods from its trade partner it is actually exporting its abundant labor which is embodied in its L-intensive exportable goods in a relatively larger proportion while its scarce capital, embodied in a relatively larger proportion in K-intensive imports, is introduced from abroad. Consequently, the degree of L-intensity and K-scarcity of this Country will necessarily decrease. The opposite development happens in its trade partner’s economy. So we see another function of trade: Trade will substitute factor movement between two countries, to some extent. In other words, trade, movement of commodities, can be concluded as movement of factors in another form. Such effect of trade lead to the relative variations in factor prices in the two countries and ultimately results in factor price equalization between them. (W/I)i (W/I)b (W/I)a

47. Ohlin’s conclusion on Factor Price Equalization Theorem The effect of interregional trade is a tendency toward equalization of prices of productive factors. From each region goods containing a large proportion of relatively abundant and cheap factors are exported, and these factors therefore become scarcer than before, whereas, goods containing a large proportion of scarce factors are imported, and the latter factors therefore become less scarce. The same result could be obtained by a transfer of the factors. As it is, interregional trade serves as a substitute for such interregional factor movements.

48. Samuelson’s Conclusion on Factor Price Equalization Theorem Any producer must closely follow the law of economic efficiency. It is this law that makes such readjustment necessary. Paul Anthony Samuelson proved the basic principle of factor endowment theory. He concluded in his famous paper International Factor-Price Equalization Once Again published in June 1949 that factor price equalization is not just a tendency but the two exchanging nations would experience a complete factor-price equalization. The complete factor-price equalization will invariably influence the behavior of the rational producers in the two countries and, at last, leads to the readjustment of factor proportions. But such readjustment will not change the basic factor nature of factor intensities of the two goods.

49. Principle of Profit Maximization and Cost Minimization In the figure, we have an Isocost Line and several Isoquet Curves. OP is Production Expansion Line showing increases in production. The tangency of Isocost Line is actually W/I Ratio. Tangency of Isoquent Curve is really MPL/MPK. On Point E , the tangent point between Isocost Line and Isoquent Curve I1, the tangency of Isocost Line (W/I ) equals the tangence of Isoquent Curve I1 (MPL/MPK). In this sense, we conclude that only such tangent point represents the most efficient production decision to meet the requirement of theLawofEconomicEfficiency. TheLawofEconomicEfficiencyindicates that the product that could be produced by the last unit of input must equals the cost of the last unit of input. In other words Marginal Productequals Marginal Cost, MP＝MC.

50. Pre-trade and post-trade Production Decisions In order to meet requirement of profit maximization and cost minimization, The two countries readjust their production decisions after trade because of changes in factor prices, from a to a’ and from b to b’, respectively. However, such readjustment does not change the relative factor intensities of the two goods. Comparing the post-trade production decisions, a’ and b’, we see F is still relatively labor intensive than C. In addition we also see a tendency of factor price equalization between the two countries.