Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
• Chapter 4 Specific Factors and Income Distribution Introduction • So far we learned that countries are better off under free trade. • If trade is good for the economy, why is there such opposition? ECON40710 – University of Notre Dame 4-2 Introduction • Opening a country to trade has strong effects on the distribution of income within a country: – Some industries contract resulting in unemployment – Some industries expand resulting in higher factor payments • This happens because: – Resources cannot move immediately or without cost from one industry to another – Industries differ in the factors of production they demand ECON40710 – University of Notre Dame 4-3 Introduction What is the impact of trade on the distribution of income within a country? • In the Ricardian model, there is only one factor of production (labor), so we cannot study the effect of trade on income distribution. • We need to develop new models that include multiple factors of production. ECON40710 – University of Notre Dame 4-4 Multi-factor models 1. Specific-factors model (Chapter 4) – The specific-factors model is a short-run model – Some factors are specific to each sectors and cannot relocate across sectors 2. Heckscher-Ohlin model (Chapter 5) – The Heckscher-Ohlin model is a long-run model – Factors can relocate across sectors at no costs ECON40710 – University of Notre Dame 4-5 Multi-factor models • Recall that there are potential gains from trade whenever there is cross-country variation in autarky prices. • In the Ricardian model, differences in autarky prices come from differences in technologies across countries. • In the Multi-factor models: – Technologies are the same in all countries – Trade patterns are explained by cross-country differences in relative factor endowments ECON40710 – University of Notre Dame 4-6 The Specific-Factors Model • Assumptions • Earnings of labor • Earnings of specific factors • Summary and conclusions ECON40710 – University of Notre Dame 4-7 Specific-Factors Model • Assumptions of the model 1. Two sectors: Agriculture and Manufacture 2. Three factors of production: labor (L), capital (K) and land (T for terrain) 3. Perfect competition prevails in all markets ECON40710 – University of Notre Dame 4-8 Specific-Factors Model 1. Supply • The economy produces Manufacturing and Agricultural goods – Manufacturing uses labor and capital: – Agriculture uses labor and land: Q M = FM (L M , K M ) Q A = FA (L A , TA ) • Labor is perfectly mobile across sectors but capital and land are specific to their industry. – For simplicity, factors cannot relocate across countries. ECON40710 – University of Notre Dame 4-9 Specific-Factors Model • Full employment in factor markets implies that supply is equal to demand: LM + LA = L KM = K TA = T ECON40710 – University of Notre Dame 4-10 Specific-Factors Model § In each industry, the marginal product of labor declines as the amount of labor used in the industry increases. § This happens because there is a fixed amount of the specific factor. ECON40710 – University of Notre Dame 4-11 Specific-Factors Model ¶Q A MPL A MRT = =¶Q M MPL M MPL M MPLA ECON40710 – University of Notre Dame 4-12 Specific-Factors Model Production Possibilities Frontier ECON40710 – University of Notre Dame 4-13 Specific-Factors Model • The profit maximization problem can be written as: max Π = 𝑃' 𝑄' + 𝑃* 𝑄* − 𝑊' 𝐿' − 𝑊* 𝐿* − 𝑅/ 𝐾' − 𝑅1 𝑇* s.t. 𝑄' = 𝐹' (𝐿' , 𝐾' ) 𝑄* = 𝐹* (𝐿* , 𝑇' ) 𝐿7 = 𝐿' + 𝐿* 8 = 𝐾' 𝐾 𝑇7 = 𝑇* 𝑊* = 𝑊' = 𝑊 ECON40710 – University of Notre Dame 4-14 Specific-Factors Model • After replacing with the constraint in the objective function we get 8 + 𝑃* 𝐹* 𝐿7 − 𝐿' , 𝑇7 − 𝑊𝐿 8 − 𝑅/ 𝐾 8 − 𝑅1 𝑇7 max Π = 𝑃' 𝐹' 𝐿' , 𝐾 • The only choice variable is 𝐿' . The first order condition is given by: ; ; 8 − 𝑃* 𝐹*,: 𝑃' 𝐹',: 𝐿' , 𝐾 𝐿7 − 𝐿' , 𝑇7 = 0 ó ; 𝐹*,: 𝐿7 − 𝐿' , 𝑇7 𝑃' =− ≡ 𝑀𝑅𝑇 ; 8 𝑃* 𝐹',: 𝐿' , 𝐾 ECON40710 – University of Notre Dame 4-15 Specific-Factors Model 2. Demand • Assume that consumer preferences can be represented by wellbehaved indifference curves • The representative consumer maximizes utility subject to the budget constraint. • The optimal relative demand for good M is such that MRS = − ECON40710 – University of Notre Dame PM PA 4-16 Specific-Factors Model 3. Equilibrium • Consumers maximize their utility: MRS = − • Firms maximize profits: MRT = − PM PA PM PA • All markets clear ECON40710 – University of Notre Dame 4-17 Specific-Factors Model • In a competitive economy, profit maximizing firms will hire labor up to the point where the marginal cost of labor equals the marginal revenue. W = P ´ MPL • Since labor is perfectly mobile across sectors, the wage rate must be the same in both sectors whenever both goods are produced: W = PA ´ MPLA = PM ´ MPLM • This implies that the closed economy equilibrium relative price is equal to the opportunity cost: PA MPLM = PM MPLA ECON40710 – University of Notre Dame 4-18 Specific-Factors Model 4. Foreign country • Same as Home expect for endowments of labor, capital, and land • Assume Home has comparative advantage in manufacturing – The autarky relative price of manufactures in Foreign is higher than in Home ( PM*/PA* > PM/PA ) – When trade is allowed the relative price of manufacturing goes up in Home ECON40710 – University of Notre Dame 4-19 Specific-Factors Model 5. Autarky and Trade Equilibrium QA Slope = –(PM/PA)W § Autarky (point A): production and consumption are equal. § With trade supply (B) and demand (C) no longer need to be equal. § Home exports M and imports A A U1 B PPF ECON40710 – University of Notre Dame § The rise in utility from U1 to U2 is a measure of the gains from trade for the QM economy. 4-20 Specific-Factors Model • As in the Ricardian model, the country’s aggregate consumption is higher so welfare for the average consumer is higher. • However, in the specific factors model that does not imply that everyone is better off. When input ownership is not distributed evenly across consumers, there will be both losers and winners How are earnings of labor, capital, and land affected in importing and exporting industries after trade? • Specific factors model notes ECON40710 – University of Notre Dame 4-21 Summary • Following an increase in the relative price of manufactures: – Labor can buy more food but less manufactures. So the welfare effect on workers (the mobile factor) is ambiguous. – Capital (specific to manufactures, the export good) owners can afford more of both goods, they are better off. – Land (specific to agriculture, the import good) owners can afford less of both goods, they are worst off. ECON40710 – University of Notre Dame 4-22 Trade Policy • In the specific-factors, trade benefits a country by expanding choices but not everyone gains from trade. • However, those who gain from trade could compensate those who lose and still be better off themselves. • Redistribution usually hard to implement. ECON40710 – University of Notre Dame 4-23 Trade Policy • Trade shifts jobs from import-competing to export-competing sectors. – Process not instantaneous – some workers will be unemployed as they look for new jobs – Governments usually provide a safety net of income support to cushion the losses to groups hurt by trade (or other changes) • How much unemployment can be traced back to changes in trade policy? – No clear pattern ECON40710 – University of Notre Dame 4-24 Trade Policy ECON40710 – University of Notre Dame 4-25 Trade Policy • Trade policy must weigh one group s gain against another s loss – Some groups may need special treatment because they are already relatively poor – Typically, those who gain from trade are a much more concentrated, informed, and organized group than those who lose ECON40710 – University of Notre Dame 4-26 Trade Policy • Economists tend to favor free trade – It is easier to use “macro” policies than to regulated each industries separately – Policies introduce distortions which makes it difficult to evaluate their (full general equilibrium) impact ECON40710 – University of Notre Dame 4-27 Conclusion In the specific-factors model an increase in the relative price of an industry’s output will: • Have an ambiguous impact on the welfare of the mobile factor • Increase the real rental earned by the factor specific to that industry • Decrease the real rental of factors specific to other industry ECON40710 – University of Notre Dame 4-28 Conclusion In the specific-factors model: – Trade benefits a country by expanding choices – Not everyone gains from trade • However, the gains outweigh the losses: – Those who gain from trade could compensate those who lose and still be better off themselves – That everyone could gain from trade does not mean that they actually do – redistribution usually hard to implement ECON40710 – University of Notre Dame 4-29