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Factor price equalization

Factor price equalization Definition

Factor price equalization is an economic theory, which states that the relative prices for two identical factors of production in the same market will eventually equal each other because of competition. The price for each single factor need not become equal, but relative factors will. Whichever factor receives the lowest price before two countries integrate economically and effectively become one market will therefore tend to become more expensive relative to other factors in the economy, while those with the highest price will tend to become cheaper.


An often-cited example of factor price equalization is wages. When two countries enter a free trade agreement, wages for identical jobs in both countries tend to approach each other. After NAFTA was signed, for instance, unskilled labor wages gradually fell in the United States, at the same time as they gradually rose in Mexico. The same force has applied more recently to the various countries of the European Union.





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