A note on the Stolper-Samuelson Theorem

May 3, 2005

Preliminaries

Lets start with some notation. Consider a variable z. Then a change in the variable z is given
by dz. A percentage change in z (e.g. Variable z has increased by 10%) is given by dz/z.
To simplify notation we set
z

dz
z

Obviously, both dz and z can take both positive and negative values. A first question we can
ask ourselves is how will a sum change when its components change?
Suppose z = x + y then a change in z is given by dz = d(x + y) = dx + dy. Furthermore,
straightforward algebra gives us
dz
z

=
=
=

dx + dy
x+y
dx
dy
+
x+y x+y
x dx
y dy
+
x+y x
x+y y

This means that

x
y
dz
= z =
x
+
y
z
x+y
x+y
We set
x =

x
y
and y =
x+y
x+y
1

In other words, x and y represent the shares (i.e. the importance) in the sum z of x and y.
This means that the equation can be rewritten as
z = x x
+ y y
In words, the percentage change of a sum=weighted sum of percentage changes of its components where the weights are the shares of the component in the sum.
A second question we can ask ourselves is how will a ratio change when its components (i.e.
numerator and denominator) change.
Suppose that
z=

x
y

then a change in z is given by

dz

x
y
dxy xdy
y2
dx x dy

y
y y

= d
=
=

and a percentage change in z is given by

d
z =
=
=
=
=
=

x
y
x
y

x y
d
y x

dx x dy y

y
y y x
x dy y
dx y

y x y y x
dx dy

x
y
xy

z = x
y
In words, a percentage change in a ratio is simply given (the percentage in the numerator) (the percentage change in the denominator).
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This can be applied to a change in real wage:

w
dwp wdp
d
=
p
p2
dw w dp
=

p
p p

w

d p
w p
dw dp
= d
=

w
p
w
w
p
p

w
= w
p
p
In other words, a percentage change in the real wage will be the dierence between the percentage in the wage minus the percentage change in the prices. Note that this result can be
applied to any ratio (also change in relative price of a good).

Stolper-Samuelson Theorem

Lets consider two industries, producing good 1 and good 2 respectively. Both industries use
both capital and labour to produce their goods but indierent intensities (factor intensities).
In order to produce one unit of the good industry i requires aLi units of labour and aKi units
of capital. The assumption that we will be making is that
aK2
aK1
>
aL1
aL2
In other words, good 1 is relatively more capital intensive and good 2 is relatively more labour
intensive.
The cost of labour (the wage) is w and the cost of capital is r. Hence, the cost of producing
one unit of the good (the marginal cost) is equal to aLi w + aKi r. In perfect competition, the
price of a good is equal to the marginal cost of production. This means that in an industry i
the price will be given by:
Pi = M C (w, r) = aLi w + aKi r
Another question that we can ask ourselves is how the price of the good will change if
e.g. the wage increases by 10% and the cost of capital by 20%. This can be computed in the
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following way:
Pi
dPi
dPi
Pi

Pi

= M C (w, r) = aLi w + aKi r

= dM C (w, r)
dM C (w, r)
=
MC

1
M C
M C
=
dw +
dr
MC
w
r
1
(aLi dw + aKi dr)
=
MC
aLi
aKi
=
dw +
dr
MC
MC
aLi w dw aKi r dr
=
+
MC w
MC r
= Li w
+ Ki r

(1)

where
Li =

aLi w
aLi w + aKi r

and Ki =

aKi r
aLi w + aKi r

In other words Li respresents the share of the labour cost in the marginal cost and Ki
represents the share of the capital cost in the marginal cost. Since both represent shares we
have Li + Ki = 1. This implies that
Ki = 1 Li

and Li = 1 Ki

Applying equation (1) to both industries we have

P1

= L1 w
+ K1 r

M C1

= aL1 w + aK1 r
aL1 w
=
aL1 w + aK1 r
= L2 w
+ K2 r

L1
P2
M C2
L2

= aL2 w + aK2 r
aL2 w
=
aL2 w + aK2 r

(2)

and K1 =

aK1 r
aL1 w + aK1 r
(3)

and K2 =

aK2 r
aL2 w + aK2 r

Using equations (2) and (3), we can compute the dierence in percentage change of both prices

as follows:
P1 P2

= L1 w
+ K1 r L2 w
K2 r
= L1 w
+ (1 L1 ) r L2 w
(1 L2 ) r
= r + L1 (w
r) r L2 (w
r)
= (L1 L2 ) (w
r)

This last line can be rewritten as

w
r =

1
P1 P2
L1 L2

In other words, the dierence in the percentage change in the income of labour and that of
capital, depends on 1) the dierence in labour shares of both products (L1 L2 ), and 2)
the dierence in percentage change of the prices of the two products. By assumption, we will
look at a case where the relative price of good 1 increases. In other words, a situation where
P1 P2 > 0. In order to determine the sign of w
r we need to determine the sign of L1 L2 .
This is done as follows.
L1 L2

aL1 w
aL2 w

<0
aL1 w + aK1 r aL2 w + aK2 r
aL1
aL2

<0
aL1 w + aK1 r aL2 w + aK2 r
aL1
aL2

<
aL1 w + aK1 r
aL2 w + aK2 r
aL1 aL2 w + aL1 aK2 r < aL1 aL2 w + aK1 aL2 r
=

aL1 aK2 r < aK1 aL2 r

aK2
aK1

<
aL2
aL1
L1 < L2
In words, this result tells us that the share of the labour cost in the marginal cost of production
the be the largest for the good which is labour intensive (here: good 2).
With this we can establish the first result of the Stolper-Samuelson theorem:
P1 P2

> 0

w
r < 0
r > w

In other words, if P1 increases faster than P2 then - because it is a capital intensive good
(L1 < L2 ) - the income (cost) of capital will increase faster than the wage.
The Stolper-Samuelson theorem goes even further. It expresses the result not only in terms
of nominal returns (incomes) but also in terms of real incomes. In other words, the StolperSamuelson theorem predicts that the owners of one factor of production will become richer
(i.e. will be able to buy more) while the owners of the other factor of production will become
poorer (i.e. will be able to buy less). This is shown in the following way:
P1

= L1 w
+ K1 r

P1

= L1 w
+ r L1 r

P1

= L1 (w
r) + r

P1

< r

P2

(4)

= L2 w
+ K2 r
= w
K2 w
+ K2 r
= w
K2 (w
r)

P2

> w

Putting these dierent elements together we have

r > P1 > P2 > w

Change in the real income of factor owners of capital

- in terms of good 1: r P1 > 0; Following an increase in relative price of good 1, owners
of capital can buy more of good 1.
- in terms of good 2: r P2 > 0; Following an increase in relative price of good 1, owners
of capital can buy more of good 2.
This means that following an increase in the relative price of good 1, the consumption
possibilities of capital owners increase; they become richer.
Change in the real income of factor owners of labour (=workers)
- in terms of good 1: w
P1 < 0; Following an increase in relative price of good 1, owners
of labour can buy less of good 1.
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- in terms of good 2: w
P2 < 0; Following an increase in relative price of good 1, owners
of labour can buy less of good 2.
This means that following an increase in the relative price of good 1, the consumption
possibilities of labour owners decrease; they become poorer.

Graph

In this section, we will show the Stolper-Samuelson theorem using a graph. As before we
assume that
aK2
aK1
>
aL1
aL2
Because both industries are in perfect competition, the price of each good is equal to its
marginal cost:
P1

= aL1 w + aK1 r

(5)

P2

= aL2 w + aK2 r

(6)

Notice that while the prices, the unit labour requirements and the unit capital requirements all
have indices (either 1 or 2), the factor prices, w and r, dont. This is because even though the
industries are dierent, both have to pay the same wage and the same cost of capital. These
prices are determined by the factor markets and cannot be influenced by the firms.
Equations (5) and (6) can be plotted in the (w,r) space. To make things a little easier, well
rewrite these two equations as
r

P1
aL1

w
aK1
aK1
P2
aL2

w
aK2
aK2

Figure 1
The red line represents all the combinations of w and r for which industry 1 is in equilibrium.
This will be the case when there are no profits and hence no entry in industry 1. Similarly, the
green line represents the combinations for which industry 2 is in equilibrium. Obviously, from
the graph, it is clear that the whole economy, that is both industry 1 and 2, is in equilibrium
at the intersection of the two lines. Hence point A represents the equilibrium
The Stolper-Samuelson theorem makes a prediction about how factor prices change when
goods prices change. To simplify things, we will assume that only P1 increases (P1 > 0) while
P2 remains the same (P2 = 0). This means that we still have the relative price of good 1
increasing since P1 P2 > 0. The Stolper-Samuelson theorem predicts that

r > P1 > 0 = P2 > w

Consider Figure 2. This represents exactly the same as in Figure 1, except that here we are
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focussing on changes of factor prices and goods prices. If we take point A as reference point,
we can draw in addition to the 45 line two other lines through point A, a horizontal blue line
and a vertical blue line. This divides the whole space in 6 dierent areas.

Figure 2
For example, the horizontal blue line represents the combinations of points were r has not
changed compared to point A. In addition, points on that blue line on the right of A represent
outcomes where r has not changed while w has increased. Similarly, points on the left of A
represent where r has not changed and w has decreased. The 45 line represents outcome where
both r and w increase in the same proportions. Points on the 45 line above point A represent
outcome where r and w are identical and bigger than at point A. Below point A, there are still
the same, but smaller than at point A.
Using a similar reasoning, we can establish for each area how both factor prices have changed

compared to point A. Hence, we can easily determine on the graph, the impact of an increase
in the relative price of good 1 (P1 > 0, P2 = 0): point B is located in the area where r > 0 > w.

This is the first result of the Stolper-Samuelson Theorem: an increase in the relative price of a
good leads to an increase in the price of the factor used intensively in production of that good
and leads to a decrease in the price of the factor not used intensively.
However, the Stolper-Samuelson theorem goes even further: not only does it predict a
change in the nominal incomes, but also a change in the real incomes. Hence, some groups
in the country will become richer while others become poorer. To establish that we need to
include product prices in the analysis also. Establishing that at point B workers have become
poorer, is easy: while prices of goods have not changed (P2 = 0) or even increased (P1 > 0),
they receive less money (0 > w).
Hence, they can buy less of both goods; they become poorer.
What about the purchasing power of the capital owners? They do receive more money
(
r > 0). This means that they can buy more of good 2, since its price has not changed
(P2 = 0). For good 1, the story is slightly dierent: while they receive more money (
r > 0),
the price of good 1 has also increased (P1 > 0). They will be better o in point B compared
to point A if r P1 > 0. To establish this, consider the inequalities in orange. On the 45
line above point A, we have r = w
= P1 . In words, on the the 45 line, the price of good 1
and the prices of both factors increase in the same proportions. To establish this result, look
at equation (4). Since on this line r = w,
that equation becomes P1 = r. Any point above the
45 line we have r > w
Again using equation (4), we have r > P1 : the percentage increase
of the price of good 1 is the percentage change r and something negative. This means that r
increases more that P1 ( r > P1 ). Point B is not only above the 45 line but also left of the
vertical blue line. This means that we have r > P1 > 0 > w.
And this is the second part of the
Stolper-Samuelson Theorem: when the price of good 1 increases, because this good is capital
intensive, the real income of capital owners increases while the real income of labour owners
decreases.

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