International Trade - Theory and Policy, 2010a

would rise, while the wage rate would fall. Similarly, if the price of the labor-intensive good were to rise,
then the wage rate would rise, while the rental rate would fall.
The theorem was later generalized by Ronald Jones, who constructed a magnification effect for prices in
the context of the H-O model. The magnification effect allows for analysis of any change in the prices of
both goods and provides information about the magnitude of the effects on wages and rents. Most
importantly, the magnification effect allows one to analyze the effects of price changes on real wages and
real rents earned by workers and capital owners. This is instructive since real returns indicate the
purchasing power of wages and rents after accounting for price changes and thus are a better measure of
well-being than the wage rate or rental rate alone.
Since prices change in a country when trade liberalization occurs, the magnification effect can be applied
to yield an interesting and important result. A movement to free trade will cause the real return of a
country’s relatively abundant factor to rise, while the real return of the country’s relatively scarce factor
will fall. Thus if the United States and France are two countries that move to free trade and if the United
States is capital abundant (while France is labor abundant), then capital owners in the United States will
experience an increase in the purchasing power of their rental income (i.e., they will gain), while workers
will experience a decline in the purchasing power of their wage income (i.e., they will lose). Similarly,
workers will gain in France, but capital owners will lose.
What’s more, the country’s abundant factor benefits regardless of the industry in which it is employed.
Thus capital owners in the United States would benefit from trade even if their capital is used in the
declining import-competing sector. Similarly, workers would lose in the United States even if they are
employed in the expanding export sector.
The reasons for this result are somewhat complicated, but the gist can be given fairly easily. When a
country moves to free trade, the price of its exported goods will rise, while the price of its imported goods
will fall. The higher prices in the export industry will inspire profit-seeking firms to expand production. At
the same time, the import-competing industry, suffering from falling prices, will want to reduce
production to cut its losses. Thus capital and labor will be laid off in the import-competing sector but will
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