4. Marginal Rate of Substitution 2 0.5 20 10 1.6 2 5 10 2 0.5 1200 600 MRS WC Cheese-Wine Ratio (C/W) Wine consumed (W) Cheese consumed (C)

15. Factor Prices and Goods Prices As labor becomes more expensive relative to land, cloth, which is labor-intensive in production, finds itself at a disadvantage and becomes relatively more expensive compared to food As both Home and Foreign use the same technologies, the same FPGP curve is applicable in both countries Wage-rent ratio, w/r Relative price of cloth, P C /P F FPGP 5 17

16. Factor Prices and Input Choices As labor becomes relatively more expensive, relatively more land is used in production … But the number of acres of land per worker is always higher in food production, reflecting the assumption that food production is land intensive … of both food and cloth As labor becomes relatively more expensive, relatively more land is used in production … Wage-rent ratio, w/r Acres of Land per worker, T/L Cloth production Food production 4 12 5

17. Factor Prices and Input Choices As both Home and Foreign use the same technologies, these two curves must be true in both countries. When w/r = 5, cloth producers use 4 acres per worker in both countries and food producers use 12 acres per worker in both countries. Therefore, Foreign, which has more land per worker than Home, must produce relatively more food … Wage-rent ratio, w/r Acres of Land per worker, T/L Cloth production Food production 4 12 5

20. Relative Supplies In Figure 4-2 , we saw that at w/r = 5, Foreign must produce relatively more food and Home must produce relatively more cloth. In Figure 4-3 we saw that w/r =5 corresponds to P C /P F = 17. Therefore, Home must produce relatively more cloth at P C /P F = 17, or indeed at any other relative price. As cloth becomes more expensive relative to food, the output of cloth will increase relative to food, Therefore, the relative supply curves slope upward. Relative price of cloth, P C /P F Yards of cloth produced per calorie of food produced, Q C /Q F RS FOREIGN RS HOME 17

21. Relative Demands The H-O assumptions about preferences imply that that consumer behavior can be summarized by this Relative Demand curve and that the same curve is true in both Home and Foreign 17 3 Relative price of cloth, P C /P F Yards of cloth consumed per calorie of food consumed, Q C /Q F

24. Relative Supplies and Demands The relative supplies and demands can be combined to find the autarky relative prices in Home and Foreign Clearly, they are different Therefore, trade will occur if it is allowed Since Home and Foreign differ only in their relative factor endowments, that difference must be the reason why trade occurs RS HOME RS FOREIGN RD Foreign Home Relative price of cloth, P C /P F Yards of cloth produced per calorie of food produced, Q C /Q F

26. Factor Prices and Goods Prices Fig. 4-8 showed that, in autarky, the relative price of cloth is higher in Foreign Fig. 4-3 then shows that, in autarky, the relative price of labor must also be higher in Foreign Free trade makes the relative price of labor the same in both countries Wage-rent ratio, w/r Relative price of cloth, P C /P F FPGP Foreign Foreign Home Home Free Trade Free Trade

43. Resource Use and Resource Productivity—Cloth Production These curves reflect Diminishing Returns to each resource, which, in turn, is a consequence of the assumption of Constant Returns to Scale Similar curves can be drawn for food production Acres of land per worker, T/L Marginal Productivity Marginal Productivity of Land = Real Rent, r/P C Marginal Productivity of Labor = Real Wage, w/P C