Question

Factor-price equalization

A. prevails in the real world.

B. means that returns to all factors in a nation are equalized.

C. means that returns to each factor are equalized across free-trading countries.

D. means that the commodity-price ratio and the factor-price ratio are equalized.

Please explain why the answer is C

Answer 1

Factor-price equalization theory was propounded by Paul A. Samuelson.

This theory is based on the premise that countries have similar production technology and markets across countries are perfectly competitive.

In absence of free trade, each country faces different price for output sold in each country's market.

However, with free trade, output price becomes equal across countries.

Since, output prices gets equal across countries, price of factors of production has to be equalized as well to keep the equality of output prices.

So, the theory states that as with free-trade, factor prices (returns to a factor) gets equalized across free-trade countries.

Hence, the correct answer is the option (C).