Specific Factors Model. Chap 4

International trade

Specific Factors Model Chapter 4

International trade and distribution of income

International trade has strong effects on the distribution of income because: 1. Resources cannot move immediately or without cost from one industry to another—a short-run consequence of trade. 2. Industries demadnd different factors of production. A shift in the mix of goods a country produces will ordinarily reduce the demand for some factors of production, while raising the demand for others—a long-run consequence of trade.

Assumptions of the Model

Imagine an economy that can produce two goods: cloth and food. Instead of one factor of production, however, the country has three: labor (L), capital (K), and land (T for terrain). Cloth is produced using capital and labor (but not land), while food is produced using land and labor (but not capital). Labor is therefore a mobile factor that can be used in either sector, while land and capital are both specific factors that can be used only in one sector.

Why the PPF is curved?

In the Ricardian model, labor is the only factor of production and the PPF is a straight line because the opportunity cost of cloth in terms of food is constant. In the specific factors model, however, the addition of other factors of production changes the shape of the PPF to a curve. The curvature reflects diminishing returns to labor in each sector; these diminishing returns are the crucial difference between the specific factors and the Ricardian models.

Labor Allocation

If we shift one person-hour of labor from food to cloth, however, this extra input will increase output in that sector by the marginal product of labor in cloth, MPLC. To increase cloth output by one unit, then, we must increase labor input by 1/MPLC hours. Meanwhile, each unit of labor input shifted out of food production will lower output in that sector by the marginal product of labor in food, MPLF. To increase output of cloth by one unit, then, the economy must reduce output of food by MPLF/MPLC units. Slope of PPF = -MPLF/MPLC.

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Specific Factor Model

The Political Economy of Trade

Trade produces losers and winners, becasuse of the income distribution

The specific Factor Model informs that those who stand to lose from trade are the inmobile factors in the import sector. Some of them (specially lower-skilled workers) have a hard time transitioning from the import to sector to export sectors. Workers in the import sector earn wages below the average

The Political Economy of Trade

Despite the real importance of income distribution, most economists remain strongly in favor of free trade for 3 main reasons: 1. Income distribution effects are not specific to international trade. 2. It is always better to allow trade and compensate those who are hurt by it than to prohibit the trade 3. Those who stand to lose from increased trade are typically better organized than those who stand to gain

Income Distribution and Trade Politics

Workers who lose from trade always want to limit trade and they are often more effective politically than those who want it extended. A good example is the U.S. sugar industry, in which the government has limited imports of sugar for many years; but If producers and consumers were equally able to get their interests represented, this policy would never have been enacted. Most of the gains from the sugar import restrictions go to a small group of sugar cane farm owners and not to their employees.

International labor mobility

In the real world, restrictions on the flow of labor are legion—just about every country imposes restrictions on immigration. Thus, labor mobility is less prevalent in practice than capital mobility. It is important to understand the international economic forces that drive desired migration of workers across borders and the short-run consequences of those migration flows whenever they are realized.

Three conclusions of the figure 4-14

1. It leads to a convergence of real wage rates. Real wages rise in Home and fall in Foreign.
2. It increases the world’s output as a whole. Foreign’s output rises by the area under its marginal product curve from L1 to L2, while Home’s falls by the corresponding area under its marginal product curve.
3. Despite this gain, some people are hurt by the change. Those who would originally have worked in Home receive higher real wages, but those who would originally have worked in Foreign receive lower real wages. Landowners in Foreign benefit from the larger labor supply, but landowners in Home are made worse off.