The document discusses the Stolper-Samuelson theorem, which states that a decrease in the price of a good will lead to a decrease in the return to the factor that is used intensively in the production of that good. It will conversely lead to an increase in the return to the other factor. The theorem is based on assumptions of perfect competition and factor mobility. It predicts that increased trade with developing countries likely contributed to rising wage inequality in skilled countries. While trade increases overall welfare, it benefits some factors more than others according to their intensity of use.

1. The Stolper-Samuelson theorem
SS
Meeting 4

2. SS theorem: intro
• A fall in the relative price of a good will lead to a fall in the return to the
factor used most intensively in production of the good, and conversely, to a
rise in the return to the other factor
• ↓P good1 → ↓Return factor1 (used for good1) → ↑Return factor2 (used for good2)

3. SS is based on neoclassical assumptions:
• a world of very few produced goods
• perfect competition between and within countries
• complete factor mobility within countries (but no mobility between
countries)
• no transport costs and
• tradability of all goods

4. Application to labour
• In a model with two factors, say skilled and unskilled labour, as
countries reduce trade barriers, the relative prices of skill-intensive
goods will rise in skill-rich countries, and fall in skill-poor countries.
• As this happens, SS predict a rise in skilled wages and a fall in
unskilled wages in the skill-rich countries.

5. Blue collar workers are less likely to bargain on wages compared to
skilled workers.
White collar workers have a higher bargaining power than workers with
lower skills.
Developed country aka advanced
Skill-rich country
Developing country
Skill-poor country
Prices of Skill intensive good ↑ ↓
Skilled wage ↑
Unskilled wage ↓
Wage
inequality

6. The Stolper-Samuelson theorem
• Uses the Heckscher-Ohlin model to predict strong links between
changing trade prices and wage inequalities
• States that increased trade with developing countries has probably
played some part in the widening wage inequalities
• Supports the idea that increasing trade with developing countries has
been a major cause of the increasing inequality in certain advanced
countries (notably the USA and UK) since 1979

7. The implications of this model are disturbing
for advanced countries
• The current globalisation tendency can be seen as an opening up to
increased trade between the skill-rich advanced countries and
developing countries.
• While the H-O theory predicts this would benefit GNP in both
advanced and developing countries, in the former this would be at
the expense of falling unskilled wages and increasing inequality.

8. Benefits from trade
Developing countries Developed countries
HO + +
SS + -
(because of wage inequality)

9. How to mitigate wage inequalities
• Contrary to what Stolper-Samuelson might suggest, governments
have considerable power to mitigate rising wage differentials by use
of education and training policy to increase workforce skills
• But, Stolper-Samuelson doubts on the popular policy response: to
improve education and training

11. the dependence of prices of factors of production
on prices of goods
• w – wage (related to labour)
• r – rent of land (related to land)
• Say that the price of cloth (Pc) equals 10, while the price of food (Pf) equals 4
• 10 = Pc (cloth) = marginal costs = 10w + 5r (input coefficients x labour and land costs)
• 4 = Pf (food) = marginal costs = 2w + 4r
• This produces two equations in two unknowns. We can graph this and solve for w and r
•10w+5r=10
•2w+4r=4

12. • 10w+5r=10
• 2w+4r=4
• w=(4-4r)/2
• 10(4-4r/2)+5r=10
• 5(4-4r)+5r=10
• 20-20r+5r=10
• 20-15r=10
• 10=15r
• r=10/15 = 2/3
or
• 10w +5r = 10
• 1ow +20r = 20
• -15r = -10
• r = 2/3
• 2w+ 4(2/3)=4
• 2w=8/3=4
• 2w=4-8/3
• 2w=12/3-8/3
• 2w=4/3
• w=(4/3)/2
• w=(4/3)(1/2)
• w=2/3

13. • What happens if the price of cloth falls? We show this as an inward
shift of the price of cloth (see the doted line).
• 10w+5r=8
• 2w+4r=4

14. • Case 1:
• Pc = 10 r1 = ? w1 = ?
• Case 2:
• Pc = 8 r2 = ? w2 = ?
• Δ Pc - ?
• Land Δ r - ? r1 ˂ ? ˃ r2 (↑ ? ↓)
• Labour Δ w - ? w1 ˂ ? ˃ w2 (↑ ? ↓)

15. • You should get that r = 4/5 and w = 2/5, proving that wages fall and the
return to land rises.
• Then at the new intersection, w is much lower and the return to land
actually rises. W falls by more than Pc falls. So there is "magnification
effect" of the international price decline on the factor used intensively
to produce the good.
• Not ALL factors gain from trade. You can test it by allowing Pc to fall to 8
and recalculating the equilibrium.
• So Labour ↓, Land ↑ (because we changed the wage price)

16. Conclusion
• P good1 → ↓ P factor 1 → ↑P factor 2
• factor 1 – labour
• factor 2 – land