HW4 Solution Key
UCDavis, 160a, Spring 2008
Prof. Farshid Mojaver
Factor Mobility
Problem 1
Make an argument that
a) there is tendency for labor to migrate from the rest of the world to US
b) migration improves US GDP but lowers the GDP of the ROW
c) migration is beneficial for the migrants but huts workers in the host country
d) owners of land/capital in the host country are better of as a result of labor migration
e) the world as a whole is better as a result of migration
Look at Lecture note 5 and the explanations on one good model.
2. 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 5.12 starting from the initial equilibrium point A.
Wage, W
B
W
W'
B’
PAMPLA
PAMPL’A
OM
LM
PMMPL'M
PMMPLM
L
L'
LA
OA
L
b) What is the effect of this change on the quantity of labor in each industry and on the equilibrium
wage?
As we could see from the figure, labor hired in Manufacturing industry increases, while
labor in agriculture industry decreases. The equilibrium wage also decreases.
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?
c).
Wage, W
B
W''
W
W'
B’
PAMPLA
PAMPL’A
OM
LM
PMMPL'M
PMMPLM
L
L'
LA
OA
L
Increasing the country’s FDI level would lead to an increase in wage level. While the
total effect on the equilibrium wage of the disaster and the subsequent FDI investment is
ambiguous and depends on the magnitude of the FDI. For example, when the new VMPL
line for Manufacturing industry is the red dash line, the new equilibrium wage W'' is
lower than the original equilibrium wage W; when the new VMPL line for
Manufacturing industry is the purple dash line, the new equilibrium wage W'' is higher
than the original equilibrium wage W; finally when the new VMPL line is the blue solid
one, the FDI exactly cancels the negative impact of the disaster on wage, that is, the
equilibrium wage keeps the same level as before the disaster. In each case, it is clearly
that the agriculture industry is further damaged by the inflow of FDI: its production scale
is further decreased because of loss of labor to manufacturing industry.
3 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 laborintensive? Why?
Digital camera industry is capital-intensive while basket industry is labor-intensive. The
former utilizes much more complicated technology and therefore requires a much larger
quantity of upfront investment in research & development.
b) Suppose that foreign owners of domestic capital decide to decrease their investment. Illustrate the
effects of this change in a diagram (can use a parallel or a box). Does output in each industry
increase, decrease or stay the same? Do wages increase, decrease, or stay the same in each
industry?
b). Parallel diagram
K
EPC
(K+∆K, L)
(K, L)
QC
EPS
QS
L
or Box Diagram:
Labor allocated to digital camera
 LC
L
The
withdrawn
FDI
OC
KC

Capital
allocated to
digital camera
Total
amount of
capital in
the
economy,
K
B
Capital
allocated
to basket
K
A

KS
Ob
L
LS 
Labor allocated to basket
Total amount of labor in the economy, L
K
Check the box diagram above, note the blue lines illustrates the new allocation of labor
and capital between the two industries after the decrease in FDI. That is: the capital
intensive industry --- digital capital industry --- is shrinking and uses less labor and
capital. While on the other hand, the labor intensive industry --- basket --- is expanding
and uses more labor and capital than before the withdraw of FDI. The new equilibrium
point is at B instead of A.
Wage rate will keep at the same level as before since the world prices of products haven’t
changed.
4).Figure 5.14 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 W*NEW > 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?
This is not a stable long-run outcome. Since the Home country still offers a higher wage
than the Foreign country, the migration will not stop, instead, workers will continue to
immigrate to the Home country.
Gains to
Home
Wage, W
W
WNew
W'
W*New
W*
Gains to
Foreign
Foreign
Wage
A
B
D
Home
Wage
A*
O
L
L'
L 
O*
 L*
World Amount of Labor
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.
Yes, there are gains from immigration incurred to both Home country and Foreign
country, which are illustrated in the above graph (the purple area is gains to the Home
country, while the yellow area is gains to the Foreign country).
5. Consider a small open economy that faces constant commodity prices. There is a mobile
factor, labor, and two sector-specific factors, capital (specific to manufacturing) and land
(specific to farming).
a. In the lecture we have discussed how the changes in the resource endowment of the
economy may affect incomes of different factor owners (owners of labor - workers,
owners of capital and land). Please, summarize the results obtained for changes in capital,
land and labor. The information you were asked to summarize above should help you
answer the following applied questions.
For how nominal returns change, see the following table:
W
RK
RT
Rise in L
fall
rise
rise
Rise in K rise
fall
fall
Rise in T
rise
fall
fall
Since prices are constant, real returns change in the same direction as nominal returns.
b. Assume that under free trade Home is exporting agricultural goods in exchange for
manufacturing goods. Which factor owners may be interested in a trade-regime change
towards autarky at Home?
Home has a comparative advantage in agricultural goods. This means that under autarky
the relative price of manufacturing is higher than under free trade. We know that a higher
price means a gain for the corresponding sector-specific factor (because labor-specific
factor ratio is higher and the real return to the specific factor is higher regardless of the
scaling price). In this case, capital owners are interested in pushing for autarky. Land
owners, obviously, are interested in free trade.
c. In 1986, the price of oil on world markets dropped sharply. Since the United States is an
oil-importing country, this was widely regarded as good for the U.S. economy. Yet in
Texas and Louisiana in 1986 was a year of economic decline. Why? What will your
prediction be about the current state of economy of these states taking into account the
new price developments in the world?
Louisiana is a major oil producing state in the US with abundant crude oil reserves,
ranking 5th in production and 8th in reserves. It also has an extensive petroleum
infrastructure with a large network of crude oil, product, and liquefied petroleum gas
(LPG) pipelines and storage facilities. Same picture is observed in Texas. Since oil
related industries in these states are competing with imports and in 1986 we are talking
about the decrease in the price of imported oil, then we would observe the effects of the
decrease in price discussed previously on the incomes of the factors. Low world oil price
would put downward pressure on the incomes of the factors specific to the oil industry,
leading to an overall economic decline.
The prediction about the current situation should be just the opposite, since
currently the world oil prices are very high and would cause an increase in the incomes of
the factors specific to the oil industry. And since oil-related industries are dominant in the
two states we would expect their overall economic performance to be very good.