Homework 4
UCDavis, 160a, SSII 2008
Prof. Farshid Mojaver
Factor Movement between Countries
1. In the short-run specific-factors model, examine the impact on a small country following a
natural disaster that decreases its population. Assume that land is specific to agriculture, capital is
specific to manufacturing, and labor is free to move between the two sectors.
a. In a diagram similar to Figure 5-2, determine the impact of the decrease in workforce on
the output of each industry and the equilibrium wage.
b. What happens to the rentals on capital and land?
2. How would your answer to problem 1 change if instead we use the long-run model, with shoes
and computers produced using labor and capital?
3. Consider an increase in the supply of labor due to immigration, and use the long-run model.
Figure 5-8 shows the box diagram and the leftward shift of the origin for the computer industry.
Redraw this diagram, but instead, shift to the right the origin for shoes. That is, expand the labor
axis by the amount L, but shift it to the left rather than to the right. With the new diagram, show
how the amount of labor and capital in shoes and computers is determined, without any change in
factor prices. Carefully explain what has happened to the amount of labor and capital used in each
industry and to the output of each industry.
4. In the specific factors model for manufacturing goods and agriculture, consider a decrease in
the stock of land. For example, suppose natural disaster decreases the quantity of arable land for
planting crops.
a. Redraw Figure 5.11 starting from the initial equilibrium point A.
b. What is the effect of this change on the quantity of labor in each industry and on the
equilibrium wage?
c. Now suppose that international community wants to help the country struck by the
natural disaster and decides to do so by increasing its level of FDI. That is, the rest of the
world increases its investment in physical capital in the stricken country. What is the
effect of this policy on the equilibrium wage? What is the total effect on the equilibrium
wage of the disaster and subsequent FDI investment (Increase, decrease or ambiguous)?
Does the agriculture industry benefit or lose from the FDI?
5. According to part A of Table 5-1, what education level loses most (that is, has the greatest decrease
in wage) from immigration to the United States? Does this result depend on keeping the rental on
capital constant? Explain why or why not.
6. Now consider a long-run model for a country producing 2 products (digital cameras and
baskets) using 2 factors (capital and labor).
a. Which good would you expect to be capital-intensive? Which good would you expect to
be labor-intensive? Why?
b. Suppose that foreign owners of domestic capital decide to decrease their investment.
Illustrate the effects of this change in a box diagram. Does output in each industry
increase, decrease or stay the same? Do wages increase, decrease, or stay the same in
each industry?
7. In Table 5-2, we show the growth in the real rental and real wages in Singapore, along with the
implied productivity growth. One way to calculate the productivity growth is to take the average
of the growth in the real rental and real wage. The idea is that firms can afford to pay labor and
capital more if there is productivity growth, so in that case, real factor prices should be growing.
But if there is no productivity growth, the average of the growth in the real rental and real wage
should be close to zero.
To calculate the average of the growth in the real factor prices, we use the shares of GDP going to
capital and labor. Specifically, we multiply the growth in the real rental by the capital share of
GDP, and add the growth in the real wage multiplied by the labor share of GDP. Then answer:
a. For a capital-rich country like Singapore, the share of capital in GDP is about one half
and the share of labor is also one half. Using these shares, calculate the average of the
growth in the real rental and real wage shown in each row of Table 5-2. How do your
answers compare with the productivity growth shown in the last column of Table 5-2?
b. For an industrialized country like the United States, the share of capital in GDP is about
one third, and the share of labor in GDP is about two thirds. Using these shares, calculate
the average of the growth in the real rental and real wage shown in each row of Table 52. How do your answers now compare with the productivity growth shown in the last
column?
8. Figure 5-14 is a supply-and-demand diagram for the world labor market. Starting at points A
and A*, consider a situation where some Foreign workers migrate to Home, but not enough to
reach the equilibrium with full migration (point B). As a result of the migration, the Home wage
decreases from W to W”> W’, and the Foreign wage increases from W* to W**< W’.
a. Are there gains that accrue to the Home country? If so, redraw the graph and identify the
magnitude of the gains for each country. If not, say why not.
b. Are there gains that accrue to the Foreign country? If so, again show the magnitude of
these gains in the diagram and show the world gains.
9. A housekeeper from the Philippines is contemplating immigrating to Singapore in search of
higher wages. Suppose that the housekeeper earns approximately $2,000 annually and expects to
find a job in Singapore worth approximately $5,000 annually for a period of 3 years.
Furthermore, assume that the cost of living in Singapore is $500 more per year than at home.
a. What can we say about the productivity of housekeepers in Singapore versus the
Philippines? Explain.
b. What is the total gain to the housekeeper from migrating?
c. Is there a corresponding gain for the employer in Singapore? Explain.
d. Suppose that the housekeeper is unable to obtain a work visa abroad and faces a payment
schedule for illegal trafficking as outlined in Table 5-4.The housekeeper intends to enter
Singapore via Indonesia. Now what are the gains to the migrant? Is it still worth moving?
10. Figure 5.16 is a supply and demand diagram for the world labor market. Consider a situation
where Foreign workers immigrate to the home country, causing the Home wage to decrease to
WNEW > W’, and where the Foreign wage begins at W* and increases to WNEW > W’.
a) Is this a stable outcome in the long run? That is, would you expect this pattern of
immigration to stay the same, to reverse, or to stop at the new Home and Foreign wages?
b) Going from old wages to the new, are there gains that accrue to the Home country? Are
there gains that accrue to the Foreign country? If so, redraw the graph and identify the
magnitude of the gains for each country. If not, say why not.
Foreign Outsourcingof Goods and Services
1. Consider an outsourcing model in which the labor hours of four activities in the United States
and Mexico are as follows:
Note that labor hours in Mexico are four times those in the United States, reflecting Mexico’s
lower productivity. Also note that the ratio of skilled to unskilled labor used in each activity
increases as we move to the right, from 1/5 in assembly to 10/1 in R&D. Suppose that the wage
of U.S. unskilled workers is $10 per hour and that of skilled workers is $25 per hour and that the
wage of Mexican unskilled workers is $1 per hour and that of skilled workers is $5 per hour
(these values are made up to be convenient, not realistic). Also suppose that the trade costs are
25%, 30%, or 50%, which means that an additional 25%, 30%, or 50% is added to the costs of
outsourcing to Mexico.
a. Fill in the blank cells in the following table by computing the costs of production of each
activity in each country (two cells are filled in for you).
b. With trade costs of 50%, where is the value chain sliced? That is, which activities are
cheaper to import from Mexico and which are cheaper to produce in the United States?
c. With trade costs of 30%, and then 25%, where is the value chain sliced?
2. Consider an outsourcing model in which Home’s skilled labor has a higher relative wage than
Foreign’s skilled labor and in which the costs of capital and trade are uniform across production
activities.
a. Will Home’s outsourced production activities be high or low on the value chain for a
given product? That is, will Home outsource activities that are skilled-labor intensive or
unskilled-labor-intensive? Explain.
b. Suppose that Home uniformly increases its tariff level, effectively increasing the cost of
importing all goods and services from abroad. How does this affect the slicing of the
value chain?
c. Draw relative labor supply and demand diagrams for Home and Foreign showing the
effect of this change. What happens to the relative wage in each country?
3. Consider a U.S. firm’s production of automobiles, including R&D and component production.
a. Starting from a no-trade equilibrium in a PPF diagram, illustrate the gains from
outsourcing if the United States has comparative advantage in component production.
b. Now suppose that advances in engineering abroad decrease the relative price of research
and development. Illustrate this change on your diagram and state the implications for
production in the United States.
c. Does the U.S. firm gain from advances in research and development abroad? Explain
why or why not.
4. The diagram below shows what happened to the relative wage and relative demand for skilled
labor in the U.S. manufacturing sector during the 1990s.These points are plotted using the data
from Figures 7-6 and 7-7.
a. What must have happened to the demand and supply curves to explain this change in
relative wage and relative employment?
b. Why do you think the demand and supply curves shifted this way? (Hint: Think about
where the workers who leave manufacturing might be going.)
5. In Figure 7-12, we saw that a fall in the relative price of components leads to an increase in the
amount of components imported, but that the amount of R&D exported from Home does not
necessarily increase. To explore this further, complete the following: Let the relative price of
components continue to fall in Figure 7-12, and show in a graph what happens to the equilibrium
point on the isoquant for the final good.
6. Why is it relatively easier for an undeveloped country to export service activities through
outsourcing than to participate in the global economy by producing manufacturing components?
7. It is widely noted that although China is the favored destination for manufacturing outsourcing,
it is far behind India in the business of outsourced services. What are some differences between
these two countries that may account for this causal observation?
8. Why is the outsourcing of white-collar or skill-intensive jobs a concern for many Americans?