International Trade

1
International Trade

• Week 4 - Specific Factors Differential Gains
  from Trade

2
Specific Factors Production

• Two countries, two goods (X and Y), and two
  factors of prodn, (labor, L capital, K).
• Labor can be used in producing X or Y (i.e.
  mobile factor)
• Capital is specific to prodn of one good, KX is
  capital useful for producing X only. (i.e.
  specific or fixed factor)
• Technology
• X FX(KX, LX) and Y FY(KY, LY)
• Subject to L LX LY , KX K0X , KY K0Y
• Returns
• w wage rate, rX return to KX, rY return to
  KY,
• pX PX/PY relative price of Good X in terms of
  Y

3
Factor Endowments of Leading Industrial
Countries, of World Total 1980
Source Mutti Morici, Changing Patterns in US
Industrial Activity Comparative Advantage (1983)
4
Production Function
MP of Labor, MPLX
Output, X
X QX (KX, LX )
MPLX
Labor Input LX
Labor Input LX
5
Constructing Nations PPF

• To construct nations PPF need to combine two
  prodn functions plus labor constraint.
• Use a 4-quadrant diagram to relate the two
  prodn functions, the labor constraint, and the
  nations PPF.
• Prodn function for each good
• depends on fixed amount of its specific capital
  combined with varying quantity of labor.
• Labor constraint is that sum of labor used by
  both industries must equal total labor endowment.
• Increase labor in Good X implies equal decrease
  labor in Good Y.
• Result is more Good X, less Good Y nations PPF.

6
Specific Factors A Countrys PPF
Y
Labor in Good Y, LY
X
Labor in Good X, LX
7
Pattern of Trade

• RESULT In the specific factors model, each
  country will export the good with the absolutely
  abundant stock of specific capital, assuming
  identical endowments of labor.
• If labor endowments differ, trade pattern depends
  on prodn functions and the relative stocks of
  the specific types of capital.
• Straightforward to demonstrate this result using
  the diagram on the previous slide.
• Increase specific capital KX in Good X.
• Prodn function QX() shifts up.
• More X produced with any given LX.
• New PPF is skewed towards X, i.e. Nation should
  export X.
• Can get same result by assuming nation possesses
  superior technology for producing Good X with any
  level of labor.
• Prodn at point tangent to terms of trade line.

8
Patterns of Trade Export/Import Ratios in
Leading Industrial Countries (1979)
Source Mutti Morici, Changing Patterns in US
Industrial Activity Comparative Advantage (1983)
9
Equilibrium in the Specific Factor Model
10
Determining Prodn Equilibrium

• Equilibrium concentrates on mobile factor, Labor.
• Under perfect competition, labor earns its value
  marginal product
• wi VMPi PiMPL,i i industry i
• Labor can move to its highest value industry, so
  in equilibrium must have
• wX PXMPL,X PYMPL,Y wY
• Labor in both industries must equal labor
  endowment.
• LX LY L
• Combine VMPs and total labor constraint on one
  diagram to find equilibrium production.

11
Equilibrium for Mobile Factor
Wage Rate, wX
Wage Rate, wY
L
12
Properties of Equilibrium

• Mobile factor Labor
• Wage rate equal in both industries, given
  relative prices.
• PXMPL,X PYMPL,Y w
• Implies that prodn point will be point on PPF
  tangent to relative price line. -MPL,X
  /MPL,Y -PY/PX
• Specific Factors Capital KX, KY
• Return to specific capital in each good equals
  its VMP.
• VMP not equalized across specific capital types
  because of lack of mobility between industries.
• Within an industry, the more labor employed, the
  higher will be the MP of specific capital, and
  hence its return.

13
Price Changes Gains from Trade in the Specific
Factor Model
14
Price Changes Equilibrium

• Concerned with changes in prices of X and Y.
• Any effects on equilibrium happen through
  adjustments in market for labor, the mobile
  factor.
• Equal Proportional Change in Both PX and PY.
• Prices rise by same , leads wages to rise same
  .
• No change relative prices or labor across
  industries
• Relative Change in Px and Py.
• Price of X alone rises by given . Shifts VMPL,X
  up. Wage rate up by smaller . Real wage may rise
  or fall.
• Increase amount of labor in X, increases return
  to KX.
• Decrease amount of labor in Y, decreases return
  to KY.

15
Effect of an Increase in Price Level
Wage Rate, w
Wage Rate, w
w
VMPX
VMPY
16
Effect of a Change in Relative Price
Wage Rate, w
Wage Rate, w
PXMPLX
w
PYMPLY
LY
LX
17
Commodity Factor Prices

• RESULT The increase in a goods relative price
  benefits the specific factor used in that
  industry, reduces the real income of the other
  specific factor, and has an ambiguous effect on
  the mobile factor.
• This result has implications for who gains and
  loses from opening trade.
• Opening an economy to trade increases the export
  goods relative price compared to that in
  autarky.
• Export-specific capital benefits, Import-specific
  capital is hurt, effect of real wage of labor is
  ambiguous.
• Provides a prediction of how groups will line up
  in political debates regarding free trade or
  protectionist trade policies.
• Think steel, wood, and other primary products in
  the U.S.

18
Relative Demand Supply

• Assuming identical tastes in both countries.
• Implies Relative Demand curve is the same for
  each.
• Assuming differences in specific factor
  endowments.
• Home Country has more KX per worker than
  Foreign, while Foreign has more KY per worker
  than Home.
• Relative Supply, QX/QY, at any given relative
  price PX/PY is thus larger in Home than in
  Foreign.
• In autarky, result is relative price of X higher
  in Foreign than Home.
• Opening trade between nations leads to World
  Relative Supply Curve between RS of each nation
  in autarky.
• World RS curve intersects World RD curve at
  relative price of X lower than Foreign but higher
  than Home.
• Trade equalizes relative price of X so that Home
  exports Good X and Foreign exports Good Y.

19
Relative Supply Specific Factors
Relative Price of X
PX/PY
RDWorld
Relative Quantity of X
(qX qX)/(qY qY)
20
Growth in Factor Endowments
Capital in millions 1966, Labor in 000s of
persons, Land in 000s hectares
Source Various World Bank, ILO pubs.
21
Effects of Growth in a Specific Factor
22
Growth in Specific Factor PPF
Y
Y QY(KY , LY)
QY
1
PPF0
LY
L
QX
X
Labor in Good Y, LY
LX
L
X Q0X(K0X, LX)
Labor in Good X, LX
23
Growth in Good X Specific Capital
Wage Rate, w
Wage Rate, w
VMPX
w
VMPY
LX
24
Effects of Growth in the Mobile Factor
25
Growth in Mobile Factor PPF
Y
Y QY(KY, LY)
QY
1
PPF0
LY
L
QX
X
Labor in Good Y, LY
LX
L
X QX(K0, LX)
Labor in Good X, LX
26
Growth in Mobile Factor, Labor
Wage Rate, w
VMPX
27
Growth in Specific Factor Model

• RESULT 1 An increase in the endowment of a
  specific factor will increase the output of the
  good using that factor and decrease the output of
  the other good. Increases in the endowment of the
  mobile factor will expand both outputs.
• RESULT 2 At constant goods prices, an increase
  in the endowment of a specific factor increases
  the returns to the mobile factor and lowers real
  returns to the specific factors. An increase in
  the endowment of the mobile factor will reduce
  its own real income and increase the real returns
  to the specific factors.
• These results have implications for who gains and
  loses from trade.
• Mobile factor, labor, will oppose easier
  immigration policies while owners of specific
  capital will favor them.
• This should remind you of the recent debate over
  increasing the H-1 visa quota for technical
  workers in the U.S.
• Provide predictions of how groups will line up in
  political debates regarding free trade or
  protectionist trade policies.