Equation (1) is a household utility function in which utility depends upon the

consumption of goods and leisure by

each individual. The maximization is with respect to consumption and leisure, hired
labour and land, and household
labour and land supplied to the market and used on the household farm: , and .
Equation (2)
is a conventional budget constraint: cash expenditures on consumption, hired
labour, and rented land cannot exceed
cash revenues from farming, market labour, and land rented out. Equations (3)–(5)
define resource constraints: labour
use on the farm is household labour used on the farm plus hired labour; land use on
the farm is owned land used on
the farm plus hired land; the household's land endowment is used on its own farm or
rented out, and each individual's
time endowment equals their labour use on the farm,

Studies in the Pure Theory of International Trade

Substituting, we get
FL(OD+DB) = 1,
1
or FL = OB'
Similarly, it can be shown that FK = 1/0A.
Now suppose that AB also represents the isocost line, so that the
slope of AB equals the wage/rental ratio. PointE then furnishes the
capital/labour ratio (k = DE/OD), the capital/output ratio (CK =
DE) and the labour/output ratio (CL = OD), which are uniquely
determined, provided the entrepreneur seeks to minimise his unit
cost. Thus for any given wjr ratio, and a given technology represented
by the neo-classical production function, the equilibrium
values of k, CK and CLare uniquely determined. Furthermore, with
production taking place under conditions of perfect competition,
the commodity price from (1.7) can be expressed in terms of the
cost of capital or labour alone. That is, p = wjFL = r/FK, or, in
termsofFig.l.l,p = w.OB = r.OA.
1.2 Technical Progress
Until now we have assumed that the transformation of productive
inputs into output expressed by the production function occurs at a
given level of technology. What happens if the level of technology
itself changes over time? The production function in the general form
may then be written as
X= F(K,L,t) (1.8)
where t denotes the state of technology. The function described by
( 1.8) is assumed to possess the same properties as those characterising
(1.1) for a given state of technical know-how. In addition, F, > 0.
We have already seen that, with the neo-classical production function,
the marginal factor productivities depend solely on the factor
proportions. Since technical progress usually results in a rise in the
marginal productivity of one or both factors, the latter is also
affected by t. In other words,
FL
w = FK = w(k,t). (1.9)
Total differentiation of (1.9) yields
I
w* = Ft-fi. = -k*+a (1.10)
(J
where a = (Ijw)(owjot) dt exhibits the incidence of technical progress
on the two marginal productivities; the partial derivative
notation used in obtaining a shows that k is kept constant.
Introduction 7
Equation ( 1.1 0) enables us to explain what is widely familiar as the
Hicks [I] measure of technical progress. According to Hicks,
technical progress is neutral if, at the pre-technical change capital/
labour ratio, the marginal productivity of both factors rises in the
same proportion; technical progress is labour-using (or capitalsaving)
if the proportionate rise in the marginal productivity of
labour exceeds the corresponding rise in the marginal productivity
of capital; it is capital-using (or labour-saving) if the greater proportionate
rise in the marginal productivity occurs for capital rather
than labour. Since the capital/labour ratio has been kept constant in
obtaining tX, the sign of tX determines the nature of the Hicksian
technical improvement. Specifically, for the neutral technical change,
tX = 0; for the labour-using type of technical improvement, tX > 0;
and under the capital-using type, tX < 0. Although technical progress
normally leads to a rise in the marginal productivity of both
factors, it is at least conceivable that the factor-using type of technical
improvement could be compatible with the absolute decline
in the marginal productivity of one factor.
In the literature on economic theory, the Hicks technical progress
has been defined in still another way. Although Hicks originally
emphasised the productivity-raising role of technical innovations,
his definitions imply other ways of stating the nature of improvements
where this role is not so explicit. Under the assumed condition
of cost minimisation, the equilibrium capital/labour ratio has already
been shown to be determined solely by the wage/rental ratio which
in turn equals the ratio between the marginal productivity of labour
and capital. It follows, therefore, that there exists a dual relationship
between the marginal factor productivities and the capital/labour
ratio; the latter affects the former because of our assumption of
constant returns to scale but diminishing returns to factor proportions,
whereas the former influences the latter because of our
assumption of profit maximisation, or alternatively cost minimisation,
on the part of the producer. When technical progress is introduced,
the capital/labour ratio is also affected by the nature of the
improvement. Thus the dual of (1.9) is written as
k = k(w,t) (l.ll)
so that
k* = aw*+P (l.l2)
where p = (l/k)(okfot) dt represents the effect of technical change
8 Studies in the Pure Theory of International Trade
on the capital/labour ratio; the partial derivation notation used in
writing p implies that the factor-price ratio is kept constant; and it
is the sign of P which crucially determines the nature of technical
inventions. With the wage/rental ratio kept constant, it is not difficult
to see that p = 0 implies Hicks-neutral improvement, whereas
p ~ 0 represent capital-using and labour-using improvements,
respectively.
The Hicks definitions of technical inventions can also be illustrated
in terms of simple diagrams. Consider Fig. 1.2, where, as
before, X1 is the unit isoquant and AB represents the unit cost
associated with the production of one unit of X. Since normally
the effect of technical progress is to raise the marginal productivity
of one or both factors, the unit isoquant X1 shifts towards the origin
to X~, thereby showing that smaller quantities of capital and/or
labour are now required to produce one unit of X. In order to
determine the nature of the improvement, the change in the
marginal productivity of the two factors must be evalutated at the
original capital/labour ratio given by the slope of OE or OE',
where E' lies on the rayO£. Draw GH tangential to X~ at£'. If GH
is parallel to AB, then technical progress must be Hicks-neutral.
For the proportionate rise in the marginal productivity of capital
equals
-~Fx = -(1--/0-G,-)---(-1,/-0-A--) AG
FK (1/0A) OG
whereas the proportionate rise in the marginal productivity of
labour is given by HB/OH, so that with the Hicks-neutral improvement
requiring (AG/OG) = (HB/OH), GH must be parallel to AB
to ensure this equality. Notice further that GH parallel to AB
implies that the wage/rental ratio has remained constant at the old
capital/labour ratio. If technical progress is labour-using, then GH
will be steeper than AB to show that the proportionate rise in the
marginal productivity of labour exceeds the corresponding rise in
the marginal productivity of capital at the original capital/labour
ratio. This case is depicted in Fig. 1.3, where HB/OH > AG/OG.
The alternative way of defining the labour-using (or capital-saving)
improvement is also clear; at the same wage/rental ratio given by
the slope of MN (parallel to AB), we find that the capital/labour
ratio has declined to that represented by the slope of OQ.
Introduction 9
K
L
Figure 1.2
K
L
Figure 1.3
10 Studies in the Pure Theory of International Trade
K
L
Figure 1.4
The case of capital-using (or labour-saving) technical progress is
depicted in Fig. 1.4. Here HB/OH < AG/OG, so that at the same
capital/labour ratio the marginal productivity of capital has risen
in a greater proportion than that of labour, or equivalently, at the
same wage/rental ratio reflected by the slope of M N, the capital/
labour ratio has risen to the slope of OR.
The.stage has now been set for defining the character of technical
progress in terms of input-output coefficients. Under neutral technical
progress, the capital/output (CK) and the labour/output (Cd
coefficients decline in the same proportion at the old wage/rental
ratio. For instance, in Fig. 1.2, CK has declined from OCto OC'
and CL from OD to OD' as a result of the technical improvement,
and it can be easily seen that, with G H parallel to AB, ( CC' /OC) =
(DD'/OD). With capital-saving (or labour-using) improvement, CK
declines in a greater proportion than C L at the old wage/rental ratio,
as is the case in Fig. 1.3, where (CC'/OC) > (DD'/OD). The
opposite holds for the labour-saving (or capital-using) improvement,
as in Fig. 1.4, where (CC'/OC) < (DD'/OD).t
From this discussion and that in the previous section we conclude
that each input-output coefficient depends on the wage/rental ratio
t With non-neutral improvements, it is, of course, possible that one of the
inputoutput
coefficients may rise at the original wage/rental ratio. Figs. 1.3 and 1.4 can be
modified to portray this case.
Introduction 11
as well as on the character of technical improvements; that is,
C; = C;(w,t). ( 1.13)
This relationship will be extensively used in the an lysis of succeeding
chapters.
1.3 The Transformation Curve
One geometric tool of analysis, the use of which in trade theory has
probably surpassed the use of every other diagrammatic device, is
well known by the name of the production possibility curve or
simply the transformation curve. In an economy where all factors
of production are always fully employed in the production of two
commodities, commodity I and commodity 2, the transformation
curve simply represents the various combinations of the two outputs
or, more specifically, the maximum possible output of one
commodity, given the output of the other. In other words, the
transformation curve is a locus of efficient production points,
production efficiency being defined in the sense of what is well
known as the Pareto optimality criterion, namely, that a combination
of two outputs is efficient if every other feasible reallocation of
inputs diminishes the output of at least one commodity.
The efficiency criterion is readily established geometrically in
terms of the Edgeworth-Bowley box diagram for the case where the
two commodities, with outputs designated as X1 and X2 , are produced
with the aid of two factors of production, capital (K) and
labour (L). The dimensions of the box in Fig. 1.5 represent the total,
inelastically supplied quantities of capital and labour, so that any
point in the box reflects a certain allocation of inputs between the
two commodities, whose outputs are measured by reference to the
two origins 0 1 and 0 2 . If we assume that production functions in
both commodities are neo-classical, then the level of two outputs
can be measured by the distances of their isoquants from the respective,
origins. Here the diagonal 0 10 2 , whose slope with respect
to the 0 1 0 axis equals the overall capital/labour ratio in the
economy, plays a useful role. Since each point on an isoquant
represents the same level of output, the output of each commodity
can be measured by the distance between the respective origin and
the point of intersection between its isoquant and the diagonal.
For example, the output of the first commodity, X1 , represented
by isoquants x1 and x'1 , is given respectively by 0 1a 1 and 0 1a2 •
Similarly, the output of the second commodity, X 2 , with isoquants
12 Studies in the Pure Theory of International Trade
:! ·a
" <.J
-- Output of X 2
Figure 1.5
•'
t
>(
0
.; a. ;
0
x2 and x2, equals 0 2 b 1 and 0 2 b 2 • Clearly, then, a movement away
from 0 1 towards 0 2 is equivalent to a rise in the output of the first
commodity and a decline in the output of the second commodity.
Conversely, a movement away from 0 2 towards 0 1 signifies an
increase in the output of the second commodity at the expense of the
output of the first commodity.
Now according to the Pareto optimality criterion, maximum
efficiency in the allocation of resources is attained at points such as
A and C, where the isoquants of the two commodities are tangential
to each other. The locus of all such points, the curve 0 1 AC02 , is
called the contract curve, or simply the efficiency locus. All points
on the contract curve represent the maximum attainable output of
one commodity, given the output of the other. For example, suppose
that the output of X 2 equals 0 2 b 1 . Then the maximum possible
Introduction 13
output of X 1, equal to 0 1a 2 , is obtained at C. At any other point
the output of X 1 will be less than that at C. At point B, for instance,
X 2 still equals 0 2 b1 , but X 1 , equal to 0 1 a 1 , is less than 0 1 a 2 .t
Hence B is inferior to C.
The location of the contract curve in the box reflects a certain
assumption concerning the capital/labour ratio in two commodities.
The contract curve in the diagram lies below the diagonal because
of our implicit assumption that under all circumstances X1 is labourintensive
relative to X 2 . For example, at point A the capital/labour
ratio in X 1 , equai to the slope of 0 1 A with respect to the 0 1 0 axis,
is less than the capital/labour ratio in X 2 , which is given by the slope
of 0 2 A with respect to the 0 2 0' axis. If, instead of X 2 , X 1 was the
capital-intensive commodity, then the contract curve would lie
entirely above the diagonal.
We are now in a position to derive the transformation curve from
the contract curve. It has already been established that various
points on the diagonal represent different levels of output of each I
commodity. This measuring scale can be easily transformed to the
vertical and horizontal scale represented by the origin 0. For
instance, the output levels of X 1 , given by points a 1 and a 2 on the
diagonal, can be projected towards the 00 2 axis to points a and a',
respectively. Since the production functions are homogeneous of the
first degree, the distance 0 1 a 2 exceeds 0 1 a 1 in exactly the same proportion
as Oa' exceeds Oa. Analogously, the output levels of X 2 ,
given by points b 1 and b2 , can be projected to obtain the respective
points band b' on the horizontal axis 00 1 • In this fashion, following
the technique developed by Savosnick [2], the 002 and 00 1 axes
can be used as output scales.
The next step is to derive points in the commodity space, representing
the levels of each output along the contract curve. The output
of X1 and X 2 corresponding to point A, for instance, is given respectively
by Oa and Ob'. The output combination given by points a and
b' is then furnished by point P in the commodity space. In other
words, the output combination associated with A, when transformed
into output scale, is given by P. Similarly, the output combination at
C is represented by Q in the output space. Thus we see that to each
point on the contract curve corresponds a unique point in the
tHere and elsewhere, X1 is identified with thejth commodity as well as its output.
Furthermore, the words 'commodity', 'industry' and 'sector' will be used
synonymously.
14 Studies in the Pure Theory of International Trade