Factor Price Frontier

Published Apr 29, 2024

Definition of Factor Price Frontier

The Factor Price Frontier (FPF) is a concept from international economics that represents the relationship between the wages of labor and the return on capital (profits) in an economy. It graphically demonstrates how the wages of labor and the returns to capital are determined by the productivity of these factors in producing different goods. The FPF is dependent on the technology available in the economy and the supply of labor and capital.

Example

Consider a simple economy that produces only two goods: cars and computers. The production of cars is labor-intensive, requiring a large amount of labor but relatively less capital. On the other hand, the production of computers is capital-intensive, requiring high levels of capital but less labor.

As the economy shifts more resources towards car production, the demand for labor increases, leading to higher wages. Conversely, the demand for capital decreases, leading to lower returns on capital. This relationship between the wage rate and return on capital can be depicted on a graph as the Factor Price Frontier. At any point along the FPF, the slope indicates the trade-off between wages and returns to capital.

Why Factor Price Frontier Matters

The Factor Price Frontier is crucial for understanding how changes in the economy, such as technological advancements or shifts in the supply of labor or capital, can affect the distribution of income between labor and capital. For instance, if a new technology makes capital more productive in car production, the FPF would shift, affecting the wages of labor and returns on capital throughout the economy.

Furthermore, the FPF concept is instrumental in trade theory, especially in explaining how international trade affects the distribution of income within trading countries. According to the Heckscher-Ohlin model of international trade, countries will export goods that intensively use their abundant factor of production. This trade can lead to changes in relative factor prices (wages and returns to capital), impacting the income distribution within each country.

Frequently Asked Questions (FAQ)

How does international trade affect the Factor Price Frontier?

International trade can shift the Factor Price Frontier by changing the relative demand for labor and capital. When a country exports goods that are labor-intensive and imports goods that are capital-intensive, the demand for labor in the exporting country increases, potentially raising wages. Similarly, the demand for capital may rise in the country importing capital-intensive goods, possibly increasing the returns to capital. This shift in the FPF reflects changes in the economy’s structure due to trade.

Can technological advancements alter the Factor Price Frontier?

Yes, technological advancements can significantly alter the Factor Price Frontier. Improvements in technology can increase the productivity of labor or capital, shifting the FPF to reflect new wage and capital return ratios. For example, a technological breakthrough in manufacturing could make capital more productive, increasing the return to capital and potentially shifting labor demand towards sectors with higher labor intensity, altering wages.

What role does the supply of labor and capital play in shaping the Factor Price Frontier?

The supply of labor and capital plays a critical role in shaping the Factor Price Frontier. The FPF reflects the productivity and availability of labor and capital in producing goods. If the supply of labor increases (e.g., through population growth), it may shift the FPF, affecting the equilibrium wages and returns to capital. Similarly, an increase in capital supply, perhaps through increased savings and investment, can alter the returns to capital and wages in the economy. Changes in the supply of these factors can lead to movements along or shifts of the FPF, affecting the economy’s overall wage and capital return structure.