International Economics: Theory and

Policy
Eleventh Edition

Chapter 5
Resources and
Trade: The
Heckscher-Ohlin
Model

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Learning Objectives
5.1 Explain how differences in resources generate a
specific pattern of trade.
5.2 Discuss why the gains from trade will not be equally
spread even in the long run and identify the likely
winners and losers.
5.3 Understand the possible links between increased trade
and rising wage inequality in the developed world.
5.4 See how empirical patterns of trade and factor prices
support some (but not all) of the predictions of the
factor-proportions theory.

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Preview
• Production possibilities
• Changing the mix of inputs
• Relationships among factor prices and goods prices,
and resources and output
• Trade in the Heckscher-Ohlin model
• Factor price equalization
• Trade and income distribution
• Empirical evidence

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Introduction
• In addition to differences in labor productivity, trade occurs
due to differences in resources across countries.
• The Heckscher-Ohlin theory argues that trade occurs due
to differences in labor, labor skills, physical capital, capital,
or other factors of production across countries.
– Countries have different relative abundance of factors
of production.
– Production processes use factors of production with
different relative intensity.

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Two-Factor Heckscher-Ohlin Model
1. Two countries: home and foreign.
2. Two goods: cloth and food.
3. Two factors of production: labor and capital.
4. The mix of labor and capital used varies across goods.
5. The supply of labor and capital in each country is constant
and varies across countries.
6. In the long run, both labor and capital can move across
sectors, equalizing their returns (wage and rental rate)
across sectors.

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Production Possibilities (1 of 11)
• With more than one factor of production, the opportunity
cost in production is no longer constant and the PPF is no
longer a straight line. Why?
• Numerical example:
K = 3000, total amount of capital available for production
L = 2000, total amount of labor available for production

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Production Possibilities (2 of 11)
• Suppose use a fixed mix of capital and labor in each sector.
aKC = 2, capital used to produce one yard of cloth
aLC = 2, labor used to produce one yard of cloth
aKF = 3, capital used to produce one calorie of food
aLF = 1, labor used to produce one calorie of food

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Production Possibilities (3 of 11)
• Production possibilities describe different amounts of cloth
and food that can be produced, given factor endowments
and technology.
– QC is total yards of cloth production
– QF is total calories of food production

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Production Possibilities (4 of 11)
• Production possibilities are influenced by both capital and
labor:
– Capital used to produce cloth and food cannot exceed
the supply of capital available.

aKCQC + aKF QF £ K

– Likewise, the labor used to produce cloth and food

cannot exceed the supply of labor available.

aLCQC + aLF QF £ L

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Production Possibilities (5 of 11)
• Constraint on capital that capital used cannot exceed
supply for the numerical example:

2QC + 3QF £ 3000

• Constraint on labor that labor used cannot exceed labor

supply:

2QC + QF £ 2000

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Production Possibilities (6 of 11)
• Economy must produce subject to both constraints –
i.e., it must have enough capital and labor.
• Without factor substitution, the production possibilities
frontier is the interior of the two factor constraints.

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Production Possibilities (7 of 11)
• Max food production 1000 (point 1) fully uses capital,
with excess labor.
• Max cloth 1000 (point 2) fully uses labor, with excess
capital.
• Intersection of labor and capital constraints occurs at
500 calories of food and 750 yards of cloth (point 3).

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Figure 5.1 The Production Possibility
Frontier without Factor Substitution

If capital cannot be substituted for labor or vice versa, the production possibility
frontier in the factor-proportions model would be defined by two resource
constraints: The economy can’t use more than the available supply of labor (2,000
work-hours) or capital (3,000 machine-hours). So the production possibility frontier
is defined by the red line in this figure.
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Production Possibilities (8 of 11)
• The opportunity cost of producing one more yard of cloth,
in terms of food, is not constant:
æ2 ö
– low ç in example ÷ when the economy produces a low
è 3 ø
amount of cloth and a high amount of food
– high (2 in example) when the economy produces a high
amount of cloth and a low amount of food
• Why? Because when the economy devotes more resources
towards production of one good, the marginal productivity of
those resources tends to be low so that the opportunity cost
is high.

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Production Possibilities (9 of 11)
• The above PPF equations do not allow substitution of
capital for labor in production.
– Unit factor requirements are constant along each
line segment of the PPF.
• If producers can substitute one input for another in the
production process, then the PPF is curved (bowed).
– Opportunity cost of cloth increases as producers
make more cloth.

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Figure 5.2 The Production Possibility
Frontier with Factor Substitution

If capital can be substituted for labor and vice versa, the production
possibility frontier no longer has a kink. But it remains true that the
opportunity cost of cloth in terms of food rises as the economy’s
production mix shifts toward cloth and away from food.
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Production Possibilities (10 of 11)
• What does the country produce?
• The economy produces at the point that maximizes the
value of production, V.
• An isovalue line is a line representing a constant value
of production, V:
V = PCQC + PF QF
– where PC and PF are the prices of cloth and food.
PC
– slope of isovalue line is -
PF

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Figure 5.3 Prices and Production

The economy produces at the point that maximizes the value of

production given the prices it faces; this is the point on the highest
possible isovalue line. At that point, the opportunity cost of cloth in
terms of food is equal to the relative price of cloth, PC > PF.
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Production Possibilities (11 of 11)
• Given the relative price of cloth, the economy produces at
the point Q that touches the highest possible isovalue line.
• At that point, the relative price of cloth equals the slope of
the PPF, which equals the opportunity cost of producing
cloth.
– The trade-off in production equals the trade-off according
to market prices.

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Choosing the Mix of Inputs (1 of 2)
• Producers may choose different amounts of factors of
production used to make cloth or food.
• Their choice depends on the wage, w, paid to labor and the
rental rate, r, paid when renting capital.
• As the wage w increases relative to the rental rate r,
producers use less labor and more capital in the production
of both food and cloth.

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Figure 5.4 Input Possibilities in Food
Production

A farmer can produce a calorie of food with less capital if he or she

uses more labor, and vice versa.
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Choosing the Mix of Inputs (2 of 2)
• Assume that at any given factor prices, cloth production
uses more labor relative to capital than food production
uses:
aLC aLF LC LF
> or >
aKC aKF KC K F

• Production of cloth is relatively labor intensive, while

production of food is relatively land intensive.
• Relative factor demand curve for cloth CC lies outside
that for food FF.

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Figure 5.5 Factor Prices and Input Choices

At any given wage-rental ratio, cloth production uses a higher labor-

capital ratio; when this is the case, we say that cloth production is
labor-intensive and that food production is capital-intensive.
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Factor Prices and Goods Prices (1 of 3)
• In competitive markets, the price of a good should equal
its cost of production, which depends on the factor prices.
• How changes in the wage and rent affect the cost of
producing a good depends on the mix of factors used.
– An increase in the rental rate of capital should affect
the price of food more than the price of cloth since
food is the capital intensive industry.
w P
• Changes in are tied to changes in C .
r PW

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Figure 5.6 Factor Prices and Goods Prices

Because cloth production is labor-intensive while food production

is capital-intensive, the higher the relative cost of labor, the higher
must be the relative price of the labor-intensive good.
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Factor Prices and Goods Prices (2 of 3)
• Stolper-Samuelson theorem: If the relative price of a
good increases, then the real wage or rental rate of the
factor used intensively in the production of that good
increases, while the real wage or rental rate of the other
factor decreases.
• Any change in the relative price of goods alters the
distribution of income.

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Figure 5.7 From Goods Prices to Input
Choices

If the relative price of cloth rises, the wage-rental ratio must rise.
This will cause the labor-capital ratio used in the production of
both goods to drop.
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Factor Prices and Goods Prices (3 of 3)
PC
• An increase in the relative price of cloth, , is
PF
predicted to
w
– raise income of workers relative to that of capital owners, .
K r
– raise the ratio of capital to labor services, , used in
L
both industries.
– raise the real income (purchasing power) of workers
and lower the real income of capital owners.

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Resources and Output (1 of 3)
• How do levels of output change when the economy’s
resources change?
• Rybczynski theorem: If you hold output prices constant
as the amount of a factor of production increases, then
the supply of the good that uses this factor intensively
increases and the supply of the other good decreases.

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Resources and Output (2 of 3)
• Assume an economy’s labor force grows, which implies
L
that its ratio of labor to capital increases.
K
• Expansion of production possibilities is biased toward cloth.
• At a given relative price of cloth, the ratio of labor to capital
used in both sectors remains constant.
• To employ the additional workers, the economy expands
production of the relatively labor-intensive good cloth and
contracts production of the relatively capital-intensive good
food.

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Figure 5.8 Resources and Production
Possibilities

An increase in the supply of labor shifts the economy’s production

possibility frontier outward disproportionately in the direction of cloth
production. At an unchanged relative price of cloth, food production
declines.
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Resources and Output (3 of 3)
• An economy with a high ratio of labor to capital
produces a high output of cloth relative to food.
• Suppose that Home is relatively abundant in labor
and Foreign in capital:
L L*
>
K K*
– Likewise, Home is relatively scarce in capital and
Foreign in labor.
• Home will be relatively efficient at producing cloth because
cloth is relatively labor intensive.

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Trade in the Heckscher-Ohlin Model (1 of 5)
• The countries are assumed to have the same technology
and the same tastes.
– With the same technology, each economy has a
comparative advantage in producing the good that
relatively intensively uses the factors of production in
which the country is relatively well endowed.
– With the same tastes, the two countries will consume
cloth to food in the same ratio when faced with the
same relative price of cloth under free trade.

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Trade in the Heckscher-Ohlin Model (2 of 5)
• Since cloth is relatively labor intensive, at each relative
price of cloth to food, Home will produce a higher ratio
of cloth to food than Foreign.
– Home will have a larger relative supply of cloth to
food than Foreign.
– Home’s relative supply curve lies to the right of
Foreign’s.

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Figure 5.9 Trade Leads to a Convergence
of Relative Prices

In the absence of trade, Home’s equilibrium would be at point 1, where

domestic relative supply RS intersects the relative demand curve RD.
Similarly, Foreign’s equilibrium would be at point 3. Trade leads to a world
relative price that lies between the pretrade prices, such as at point 2.
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Trade in the Heckscher-Ohlin Model (3 of 5)
• Like the Ricardian model, the Heckscher-Ohlin model
predicts a convergence of relative prices with trade.
• With trade, the relative price of cloth rises in the relatively
labor abundant (home) country and falls in the relatively
labor scarce (foreign) country.

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Trade in the Heckscher-Ohlin Model (4 of 5)
• Relative prices and the pattern of trade: In Home, the rise
in the relative price of cloth leads to a rise in the relative
production of cloth and a fall in relative consumption of
cloth.
– Home becomes an exporter of cloth and an importer
of food.
• The decline in the relative price of cloth in Foreign leads
it to become an importer of cloth and an exporter of food.

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Trade in the Heckscher-Ohlin Model (5 of 5)
• Heckscher-Ohlin theorem: The country that is abundant
in a factor exports the good whose production is intensive
in that factor.
• This result generalizes to a correlation:
– Countries tend to export goods whose production
is intensive in factors with which the countries are
abundantly endowed.

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Trade and the Distribution of Income (1 of 5)
• Changes in relative prices can affect the earnings of labor
and capital.
– A rise in the price of cloth raises the purchasing power
of labor in terms of both goods while lowering the
purchasing power of capital in terms of both goods.
– A rise in the price of food has the reverse effect.

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Trade and the Distribution of Income (2 of 5)
• Thus, international trade can affect the distribution of
income, even in the long run:
– Owners of a country’s abundant factors gain from
trade, but owners of a country’s scarce factors lose.
– Factors of production that are used intensively by the
import-competing industry are hurt by the opening of
trade – regardless of the industry in which they are
employed.

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Trade and the Distribution of Income (3 of 5)
• Compared with the rest of the world, the United States
is abundantly endowed with highly skilled labor while
low-skilled labor is correspondingly scarce.
– International trade has the potential to make low-
skilled workers in the United States worse off - not
just temporarily, but on a sustained basis.

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Trade and the Distribution of Income (4 of 5)
• Changes in income distribution occur with every economic
change, not only international trade.
– Changes in technology, changes in consumer preferences,
exhaustion of resources and discovery of new ones all
affect income distribution.
– Economists put most of the blame on technological change
and the resulting premium paid on education as the major
cause of increasing income inequality in the US.
• It would be better to compensate the losers from trade (or any
economic change) than prohibit trade.
– The economy as a whole does benefit from trade.

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Trade and the Distribution of Income (5 of 5)
• There is a political bias in trade politics: potential losers
from trade are better politically organized than the winners
from trade.
– Losses are usually concentrated among a few, but
gains are usually dispersed among many.
– Each of you pays about $8/year to restrict imports of
sugar, and the total cost of this policy is about $2
billion/year.
– The benefits of this program total about $1 billion, but
this amount goes to relatively few sugar producers.

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North-South Trade and Income
Inequality (1 of 4)
• Over the last 40 years, countries like South Korea,
Mexico, and China have exported to the U.S. goods
intensive in unskilled labor (ex., clothing, shoes, toys,
assembled goods).
• At the same time, income inequality has increased in the
U.S., as wages of unskilled workers have grown slowly
compared to those of skilled workers.
• Did the former trend cause the latter trend?

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North-South Trade and Income
Inequality (2 of 4)
• The Heckscher-Ohlin model predicts that owners of
relatively abundant factors will gain from trade and
owners of relatively scarce factors will lose from trade.
– Little evidence supporting this prediction exists.
1. According to the model, a change in the distribution of
income occurs through changes in output prices, but
there is no evidence of a change in the prices of skill-
intensive goods relative to prices of unskilled-intensive
goods.

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North-South Trade and Income
Inequality (3 of 4)
2. According to the model, wages of unskilled workers
should increase in unskilled labor abundant countries
relative to wages of skilled labor, but in some cases
the reverse has occurred:
– Wages of skilled labor have increased more rapidly
in Mexico than wages of unskilled labor.
– But compared to the U.S. and Canada, Mexico is
supposed to be abundant in unskilled workers.

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North-South Trade and Income
Inequality (4 of 4)
3. Even if the model were exactly correct, trade is a small
fraction of the U.S. economy, so its effects on U.S. prices
and wages prices should be small.
• The majority view of trade economists is that the villain is
not trade but rather new production technologies that put a
greater emphasis on worker skills (such as the widespread
introduction of computers and other advanced technologies
in the workplace).

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Skill-Biased Technological Change and
Income Inequality (1 of 2)
• Even though skilled labor becomes relatively more
expensive, in panel (b) producers in both sectors respond
to the skill-biased technological change by increasing their
employment of skilled workers relative to unskilled workers.
– The trade explanation in panel (a) predicts an opposite
response for employment in both sectors.
• A widespread increase in the skilled labor ratios for most
sectors in the U.S. economy points to the skill-biased
technological explanation.

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Skill-Biased Technological Change and
Income Inequality (2 of 2)
• Trade likely has been an indirect contributor to increases
in wage inequality, by accelerating the process of
technological change.
– Firms that begin to export may upgrade to more skill-
intensive production technologies.
– Trade liberalization can then generate widespread
technological change by inducing a large proportion
of firms to make such technology-upgrade choices.
• Breaking up the production process across countries
can increase the relative demand for skilled workers in
developed countries similar to skill-biased technological
change.
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Figure 5.10 Increased Wage Inequality:
Trade or Skill-Biased Technological Change?

The LL and HH curves show the skilled-unskilled employment ratio as a

function of the skilled-unskilled wage ratio in the low-tech and high-tech
sectors. The high-tech sector is more skill-intensive than the low-tech
sector, so the HH curve is shifted out relative to the LL curve.
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Figure 5.11 Evolution of U.S. Non-Production–
Production Employment Ratios in Four Groups
of Sectors

Sectors are grouped based on their skill intensity. The non-production–production

employment ratio has increased over time in all four sector groups.
Source: NBER-CES Manufacturing Productivity Database.
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Capital-Skill Complementarity (1 of 2)
• Figure 5-12 shows that the trend toward lower labor
income share (and higher capital shares) is a worldwide
phenomenon.
– Experienced in labor-abundant countries (including
China, India, and Mexico) to the same extent as it has
been for capital-abundant countries such as the United
States.
• The evidence supports an explanation based on
technological changes within sectors – not increased
import competition.

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Capital-Skill Complementarity (2 of 2)
• Technological change often takes the form of new and
better machines (capital) that displace unskilled workers
but still require skilled workers.
– This generates higher returns for both capital and
skilled workers while depressing the returns to
unskilled workers.
• Increased automation can explain the observed worldwide
increases in both wage inequality and the returns to
capital, as well as the within-sector increases in the
employment share of (relatively skilled) non-production
workers.

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Figure 5.12 U.S. and Average World
Corporate Labor Share

Unweighted world average for all 59 countries with available data.

Source: Loukas Karabarbounis and Brent Neiman, “The Global
Decline of the Labor Share,” The Quarterly Journal of Economics
129.1 (2014), pp. 61–103.
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Factor Price Equalization (1 of 3)
• Unlike the Ricardian model, the Heckscher-Ohlin model
predicts that factor prices will be equalized among countries
that trade.
• Free trade equalizes relative output prices.
• Due to the connection between output prices and factor
prices, factor prices are also equalized.
• Trade increases the demand of goods produced by relatively
abundant factors, indirectly increasing the demand of these
factors, raising the prices of the relatively abundant factors.

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Factor Price Equalization (2 of 3)
• In the real world, factor prices are not equal across
countries.
• The model assumes that trading countries produce the
same goods, but countries may produce different goods if
their factor ratios radically differ.
• The model also assumes that trading countries have the
same technology, but different technologies could affect
the productivities of factors and therefore the wages/rates
paid to these factors.

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Table 5.1 Comparative International
Wage Rates
Hourly Compensation of
Manufacturing Workers 2015
Country (United States = 100)
United States 100
Germany 112
Japan 63
Spain 63
South Korea 60
Brazil 31
Mexico 16
China (2013) 11.3
India (2012) 4.5
Source: The Conference Board, International Labor Comparisons.

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Factor Price Equalization (3 of 3)
• The model also ignores trade barriers and transportation
costs, which may prevent output prices and thus factor
prices from equalizing.
• The model predicts outcomes for the long run, but after
an economy liberalizes trade, factors of production may
not quickly move to the industries that intensively use
abundant factors.
– In the short run, the productivity of factors will be
determined by their use in their current industry, so
that their wage/rental rate may vary across countries.

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Empirical Evidence on the Heckscher-
Ohlin Model (1 of 6)
• Tests on US data
– Leontief found that U.S. exports were less capital-
intensive than U.S. imports, even though the U.S. is the
most capital-abundant country in the world: Leontief
paradox.
• Tests on global data
– Bowen, Leamer, and Sveikauskas tested the Heckscher-
Ohlin model on data from 27 countries and confirmed the
Leontief paradox on an international level.

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Table 5.2 Factor Content of U.S. Exports
and Imports for 1962

blank Imports Exports

Capital per million dollars $2,132,000 $1,876,000
Labor (person-years) per million dollars 119 131
Capital-labor ratio (dollars per worker) $17,916 $14,321
Average years of education per worker 9.9 10.1
Proportion of engineers and scientists in
work force 0.0189 0.0255

Source: Robert Baldwin, “Determinants of the Commodity Structure of

U.S. Trade,” American Economic Review 61 (March 1971), pp. 126-145.

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Table 5.3 Estimated Technological
Efficiency, 1983

Country blank
Bangladesh 0.03
Thailand 0.17
Hong Kong 0.40
Japan 0.70
West Germany 0.78
United States 1
Source: Daniel Trefler, “The Case of the Missing Trade and Other mysteries,”
American Economic Review (December 1995), pp. 1029-1046.

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Empirical Evidence on the Heckscher-
Ohlin Model (2 of 6)
• Because the Heckscher-Ohlin model predicts that factor
prices will be equalized across trading countries, it also
predicts that factors of production will produce and export
a certain quantity goods until factor prices are equalized.
– In other words, a predicted value of services from
factors of production will be embodied in a predicted
volume of trade between countries.

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Empirical Evidence on the Heckscher-
Ohlin Model (3 of 6)
• But because factor prices are not equalized across
countries, the predicted volume of trade is much larger
than actually occurs.
– A result of missing trade discovered by Daniel Trefler.
• The reason for this missing trade appears to be the
assumption of identical technology among countries.
– Technology affects the productivity of workers and
therefore the value of labor services.
– A country with high technology and a high value of
labor services would not necessarily import a lot from
a country with low technology and a low value of labor
services.
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Empirical Evidence on the Heckscher-
Ohlin Model (4 of 6)
• An important study by Donald Davis and David Weinstein
showed that if relax the assumption of common
technologies, along with assumptions underlying factor
price equalization (countries produce the same goods
and costless trade equalizes prices of goods):
– then the predictions for the direction and volume of
the factor content of trade line-up well with empirical
evidence and ultimately generate a good fit.
• Difficulty finding support for the predictions of the pure
Heckscher-Ohlin model can be blamed on some of the
assumptions made.

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Table 5.4 A Better Empirical Fit for
the Factor Content of Trade
Assumptions Assumptions Assumptions Assumptions
Dropped Dropped Dropped Dropped
blank None Drop (1) Drop (1)-(2) Drop (1)-(3)
Predictive Success
(sign test) 0.32 0.50 0.86 0.91
Missing Trade
(observed/predicted) 0.0005 0.008 0.19 0.69

Assumptions: (1) common technologies across countries; (2) countries produce the
same set of goods; and (3) costless trade equalizes goods prices.
Source: Donald R. Davis and David Weinstein, “An Account of Global Factor Trade,”
American Economic Review (2001), pp. 1423–1453.

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Empirical Evidence on the Heckscher-
Ohlin Model (5 of 6)
• Contrast the exports of labor-abundant, skill-scarce
nations in the developing world with the exports of skill-
abundant, labor-scarce (rich) nations.
– The exports of the three developing countries to the
United States are concentrated in sectors with the
lowest skill-intensity.
– The exports of the three skill abundant countries to
the United States are concentrated in sectors with
higher skill intensity.

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Figure 5.13 Export Patterns for a Few Developed
and Developing Countries, 2008–2012

Source: NBER-CES U.S. Manufacturing Productivity Database, U.S.

Census Bureau, and Peter K. Schott, “The Relative Sophistication of
Chinese Exports,” Economic Policy (2008), pp. 5–49.
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Empirical Evidence on the Heckscher-
Ohlin Model (6 of 6)
• Or compare how exports change when a country such as
China grows and becomes relatively more skill-abundant:
– The concentration of exports in high-skill sectors
steadily increases over time.
– In the most recent years, the greatest share of exports
is transacted in the highest skill-intensity sectors,
whereas exports were concentrated in the lowest skill-
intensity sectors in the earlier years.

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Figure 5.14 Changing Pattern of Chinese
Exports over Time

Source: NBER-CES U.S. Manufacturing Productivity Database, U.S.

Census Bureau, and Peter K. Schott, “The Relative Sophistication of
Chinese Exports,” Economic Policy (2008), pp. 5–49.
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Summary (1 of 4)
1. Substitution of factors used in the production process
generates a curved PPF.
– When an economy produces a low quantity of a good,
the opportunity cost of producing that good is low.
– When an economy produces a high quantity of a good,
the opportunity cost of producing that good is high.
2. When an economy produces the most value it can from
its resources, the opportunity cost of producing a good
equals the relative price of that good in markets.

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Summary (2 of 4)
3. (Stolper-Samuelson theorem) An increase in the relative
price of a good causes the real wage or real rental rate
of the factor used intensively in the production of that
good to increase,
– while the real wage and real rental rates of other
factors of production decrease.
4. (Rybczynski theorem) If output prices remain constant as
the amount of a factor of production increases, then the
supply of the good that uses this factor intensively
increases, and the supply of the other good decreases.

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Summary (3 of 4)
5. (Heckscher-Ohlin theorem) An economy exports goods
that are relatively intensive in its relatively abundant
factors of production and imports goods that are
relatively intensive in its relatively scarce factors of
production.
6. Owners of abundant factors gain, while owners of scarce
factors lose with trade.
7. A country as a whole is predicted to be better off with
trade, so winners could in theory compensate the losers
within each country.

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Summary (4 of 4)
8. The Heckscher-Ohlin model predicts that relative output
prices and factor prices will equalize, neither of which
occurs in the real world.
9. Empirical support of the Heckscher-Ohlin model is weak
except for cases involving trade between high-income
countries and low/middle- income countries or when
technology differences are included.

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Figure 5A.1 Choosing the Optimal
Labor-Capital Ratio

To minimize costs, a producer must get to the lowest possible isocost

line; this means choosing the point on the unit isoquant (curve II)
where the slope is equal to minus the wage-rental ratio w > r.
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Figure 5A.2 Changing the Wage-Rental
Ratio

A rise in w > r shifts the lowest-cost input choice from point 1 to

point 2; that is, it leads to the choice of a lower labor-capital ratio.

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Figure 5A.3 Determining the Wage-Rental
Ratio

The two isoquants CC and FF show the inputs necessary to

produce one dollar’s worth of cloth and food, respectively. Since
price must equal the cost of production, the inputs into each good
must also cost one dollar. This means that the wage-rental ratio
must equal minus the slope of a line tangent to both isoquants.
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Figure 5A.4 A Rise in the Price of Cloth

If the price of cloth rises, a smaller output is now worth one dollar;
so CC1 is replaced by CC 2 . The implied wage-rental ratio must
therefore rise.

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Copyright

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