Chapter 3 Gains and Lossed from Trade in the Specific-Factors Model

Gains and Losses from Trade in the SpecificFactors ModelChapter 3: Gains and Losses from Trade in the Specific-Factors Model

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Specific-Factors ModelEarnings of Labor Earnings of Capital and Land

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1 Specific-Factors Model

The Home Country Home and Foreign Manufacturing uses labor and capital Agriculture uses labor and land In each industry, increases in the amount of labor used are subject to diminishing returns: the marginal product of labor declines as the amount of labor used in the industry increases

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

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1 Specific-Factors Model

The Home CountryFIGURE 3-1

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Panel (a) Manufacturing Output As more labor is used, manufacturing input increases, but it does so at a diminishing rate.

Panel (b) Diminishing Marginal Product of Labor An increase in the amount of labor used in manufacturing lowers the marginal product of labor.3 of 46

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1 Specific-Factors Model

The Home CountryProduction Possibilities FrontierFIGURE 3-2Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Production Possibilities Frontier The production possibilities frontier shows the amount of agricultural and manufacturing outputs that can be produced in the economy with labor.

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1 Specific-Factors Model

The Home CountryOpportunity Cost and Prices

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Slope of the PPF = the opportunity cost or relative price of the good on the horizontal axis (manufacturing) Firms hire labor up to the point where the cost of one more hour of labor (the wage) equals the value of one more hour of labor in production.

W PM MPLM W PA MPLA

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1 Specific-Factors Model

The Home CountryOpportunity Cost and PricesFIGURE 3-3

Increase in the Relative Price of Manufactures In the absence of international trade, the economy produces and consumes at point A. The relative price of manufactures, PM/PA, is the slope of the line tangent to the PPF and indifference curve U1, at point A. With international trade, the economy is able to produce at point B and consume at point C. The world relative price of manufactures, (PM/PA)W, is the slope of the line BC. The rise in utility from U1 to U2 is a measure of the gains from trade for the economy.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

Chapter 3: Gains and Losses from Trade in the Specific-Facto

rs Model

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Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

The Foreign Country Assume that the Home no-trade relative price of manufacturing is lower than the Foreign relative price (PM /PA) < (P*M /P*A). This assumption means that Home can produce manufactured goods relatively cheaper than Foreign Home has a comparative advantage in manufacturing.Overall Gains from Trade The good whose relative price goes up (manufacturing, for Home) is exported and the good whose relative price goes down (agriculture, for Home) is imported By exporting manufactured goods at a higher price and importing food at a lower price, Home is better off than it was in the absence of tradeCopyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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APPLICATION

How Large Are the Gains from Trade? There are a few historical examples of countries that have moved from autarky (i.e., no trade) to free trade, or vice versa, quickly enough to estimate the gains from trade. One such episode in the United States occurred between December 1807 and March 1809, when the U.S. Congress imposed a nearly complete halt to international trade at the request of President Thomas Jefferson. A complete stop to all trade is called an embargo. As you might expect, U.S. trade fell dramatically during this period. Another historical case was Japan’s rapid opening to the world economy in 1854, after 200 years of self-imposed autarky. The gains were not one-sided, however; Japan’s trading partners—such as the United States—also gained from being able to trade in the newly opened markets. ■Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

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2 Earnings of Labor Determination of WagesFIGURE 3-4 (1 of 2) Allocation of Labor between Manufacturing and Agriculture

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

The amount of labor used in manufacturing is measured from left to right along the horizontal axis, and the amount of labor used in agriculture is measured from right to left.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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2 Earnings of Labor Determination of WagesFIGURE 3-4 (2 of 2)

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Allocation of Labor between Manufacturing and Agriculture (continued) Labor market equilibrium is at point A. At the equilibrium wage of W, manufacturing uses 0ML units of labor and agriculture uses 0AL units.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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2 Earnings of Labor

Change in Relative Price of ManufacturesFIGURE 3-5

Increase in the Price of Manufactured Goods With an increase in the price of the manufactured good, the curve PM MPLM shifts up to PM MPLM and the equilibrium shi

fts from point A to point B. The amount of labor used in manufacturing rises from 0ML to 0ML , and the amount of labor used in agriculture falls from 0AL to 0AL . The wage increases from W to W , but this increase is less than the upward shift PM MPLM.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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2 Earnings of Labor

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Change in Relative Price of Manufactures Effect on the Wage An increase in the relative price of manufacturing PM/PA Either an increase in PM or a decrease in PA. Both these price movements will have the same effect on the real wage (on the amount of manufactures and food that a worker can afford to buy)

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2 Earnings of Labor

Change in Relative Price of ManufacturesFIGURE 3-5 (reproduced)

Effect on Real Wages Notice that the increase in the wage from W to W′ is less than the vertical increase ΔPM MPLM that occurred in the PM MPLM curve. When ΔW/W < ΔPM /PM, then the percentage increase in the wage is less than the percentage increase in the price of the manufactured good. This inequality means that the amount of the manufactured good that can be purchased with the wage has fallen, so the real wage in terms of the manufactured good W/PM has decreased.13 of 46

Chapter 3: Gains and Losses from Trade in the Specific-Factors ModelCopyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

2 Earnings of Labor

Change in Relative Price of ManufacturesOverall Impact on Labor In the specific-factors model, the increase in the price of the manufactured good has an ambiguous effect on the real wage and therefore an ambiguous effect on the well-being of workers. Ricardian model Labor unambiguously earned a higher real wage. The effect of trade on real wages can be complex.

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

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APPLICATION Manufacturing and Services in the United States: Employment and Wages across Sectors A larger sector in industrialized countries is that of services, which includes wholesale and retail trade, finance, law, education, information technology, software engineering, consulting, and medical and government services.

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

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APPLICATION Manufacturing and Services in the United States: Employment and Wages across SectorsFIGURE 3-6Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

U.S. Manufacturing Sector Employment, 1973–2009

Employment in the U.S. manufacturing

sector is shown on the left axis, and the share of manufacturing employment in total U.S. employment is shown on the right axis. Both manufacturing employment and its share in total employment have been falling over time, indicating that the service sector has been growing.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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APPLICATION Manufacturing and Services in the United States: Employment and Wages across SectorsFIGURE 3-7 (1 of 2) Real Hourly Earnings of Production Workers

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

This chart shows the real wages (in constant 2008 dollars) earned by production workers in U.S. manufacturing, in all private services, and in information services (a subset of all private services).

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APPLICATION Manufacturing and Services in the United States: Employment and Wages across SectorsFIGURE 3-7 (2 of 2) Real Hourly Earnings of Production Workers (continued)

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

While wages were slightly higher in manufacturing than in all private services from 1974 through 2007, all private service wages have been higher since 2008. This change is due in part to the effect of wages in the information service industry, which are substantially higher than those in manufacturing. Real wages for production workers fell in most years between 1979 and 1995 but have been rising since then.Copyright © 2011 Worth Publishers·International Economics· Feenstra/Taylor, 2/e.

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APPLICATION Manufacturing and Services in the United States: Employment and Wages across SectorsTABLE 3-1 (1 of 3)

Chapter 3: Gains and Losses from Trade in the Specific-Factors Model

Job Losses in Manufacturing and Service Industries, 2005–2009 This table shows the number of displaced (or laid-off) workers in manufacturing and service industries from 2005 to 2009.

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