The Factor Price Equalization (FPE) theorem is an economic concept that suggests that under certain assumptions, the prices of factors of production, such as labor and capital, will tend to equalize across different countries or regions in the long run. The theorem is based on the theory of comparative advantage and the assumption of perfect competition.
According to the FPE theorem, in a world with free trade and no transportation costs, factors of production will earn the same returns (or prices) across different locations. This means that the wages of workers and the returns to capital will converge across countries or regions.
The theorem relies on several key assumptions:
- Perfect competition: The FPE theorem assumes that markets for factors of production are perfectly competitive, with many buyers and sellers and no barriers to entry or exit. This assumption implies that firms and workers are price-takers and cannot influence factor prices.
- Identical production technologies: The theorem assumes that countries or regions have access to the same production technologies, allowing them to produce goods and services with the same efficiency.
- Factor mobility: The FPE theorem assumes that factors of production can move freely between countries or regions. In reality, factors such as labor and capital often face barriers to mobility, which can limit the extent of factor price equalization.
- Constant returns to scale: The theorem assumes that production exhibits constant returns to scale, meaning that doubling the inputs will double the output. This assumption ensures that factor prices can be compared across different scales of production.
It’s important to note that the FPE theorem is a theoretical concept and does not necessarily hold in the real world due to various factors such as transportation costs, differences in technology and productivity, trade barriers, and labor market frictions. However, it provides insights into the potential long-run effects of international trade on factor prices.
