The Determinants of Relative Price Differences are very useful for any economist in any given country. They tend to explain why prices of the same goods in the market are different either mostly in different parts of the country or depending on the area you are buying the goods from.
Determinants of Relative Price Differences
The Determinants of Relative Price Differences include the following;
- Unequal Relative Endowment of Factors of Production,
- Differing Proportions of which Factors are Combined
- Economies of Large Scale Production.
- Minimization of Transport Costs
Unequal Relative Endowment of Factors of Production
Unequal Relative Endowment of Factors of Production is one of the Determinants of Relative Price Differences. If we assume free markets, competitive conditions and that price in each country are determined by supply and demand the price will be fixed where the demand and supply are equal. Under these conditions, the price of the product would equal the average cost and the marginal cost. Given these relationship, we can conclude that what causes the relative cost of production to different between countries is the unequal relative endowments in productive factors in the trading countries. It is also true that technologically different commodities require different proportions of the factors of production. The more abundant the supply of a factor of production compared to other factors of production the cheaper that factor will be.
The second of the Determinants of Relative Price Differences is the differing proportions of which actors are combined. The element influencing comparative cost difference is the fact that different commodities require different proportions of factor of production. Although the proposition of factor used to produce the product may be variable within limits in most cases one ore of the factors may be per-dockhand. As a result it is common to classify a product according to whether it is labor intensive or capital or land intensive.
A country with a relatively abundant supply of labor and relatively low wage rates will produce labor-intensive goods more cheaply than countries with scarcity of labor and high wage rates. In this case, the labor abundant countries tend to have a comparative cost advantage in the production of labor intensive commodities and comparative cost disadvantage in production of lad ad capital intensive goods.
Economies of Large Scale Production as one of the Determinants of Relative Price Differences
Economies of Large Scale Production are the third factor affecting Determinants of Relative Price Differences. In some countries, there are large internal markets which encourage industries to develop a large scale output. Greater efficiency is reflected in the lower average and marginal costs of production as output increases.
Economies of scale may be internal or external. Internal are those realized by the firm as a result of large scale production. External ones may result from outside factors affecting the industry as a whole. It doesn’t matter however whether economies of scale are internal external. What is important to note is that they are associated with large scale production. A large output however is economically feasible only when the market of the product is large. Countries with small attritional market e.g. because of small populations per capita income are economies of large scale production. One of the advantages of establishing regional trading blocks organizations e.g. East African Community is to industries the size of the market. This makes it possible to establish industries that are subject to economies of large scale production and create some comparative cost advantage.
Minimization of Transport Costs
Another factor affecting Determinants of Relative Price Differences between countries is the amount of transport costs. The immediate effect of the cost of transport is to the price of goods. In general transport costs act as a deferent in geographical specialization by reducing in some cases eliminating the cost of production advantage of one country over another. Also, transport costs are an important factor to consider in the choice of the location of an industry if an industry requires various law materials available in different geographical locations regions, the industry should be located at the place where transport costs are minimized also, firms which produce heavy or bulky products are located at the coast for cheaper transport by sea.
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Conclusion on Determinants of Relative Price Differences
As seen above, Unequal Relative Endowment of Factors of Production, Differing Proportions of which Factors are Combined, Economies of Large Scale Production and Minimization of Transport Costs are the Determinants of Relative Price Differences.