Transcript Trade and Factor Prices Factor Price Equalization Trade and Input prices Stolper-Samuelson Theorem As a result of trade in each country: • The production.

Trade and Factor Prices
Factor Price Equalization
Trade and Input prices
Stolper-Samuelson Theorem
As a result of trade in each country:
• The production of the good in which the country has a
comparative advantage would increase
• Under the H-O assumptions, the production of the good
that uses the country’s abundant resource would
increase, increasing the demand for that resource (as
well as the demand for the scarce resource, but
proportionally less)while the production of the good
that uses the country’s scarce resource would decrease,
releasing both scarce and abundant resources
Production Adjustments
• As the production of the good using the abundant
resource intensively increases, demand for that
resource will increase; so will the demand for the
scarce resource, but by a smaller amount
• As the production of the good that uses the
scarce resource intensively decreases, both
abundant and scarce resources will be released,
but relatively more of the scarce resource will be
released than the abundant resource
Factor Markets
SK
SL
ro
W2
D1
D2
Do
r2
Wo
Do
L
0
Labor
D2
D1
0
Capital
K
Stolper-Samuelson Theorem
A change in the price of a (traded) good results in
a more than proportional change, in the same
direction, in the price of the factor that is used in
the production of that good more intensively; a
labor-abundant country specializing (and
exporting) the labor intensive good will see an
increase in its wages proportionally more than the
increase in the relative price of the labor intensive
good.
As a result of trade:
under the H-O assumptions,
• The price of the abundant factor will increase
proportionally more than the increase in the price of the
good that uses the abundant factor intensively: that
results in an increase in the real wages in the laborabundant country.
• The price of the scarce resource will decrease
proportionally more than the decline the relative price
of the good that uses the scarce resource intensively: a
decrease in the real price of the scarce resource; the
rental price of capital in the capital-poor country will
decrease:
WA
WB
rA
rB
Factor Price Equalization
A Simple Approach
A One-Input World
Recall that (in a Ricardian world):
PA = aA . WA
PB = aB . WB
If
PA = PB ==> aA . WA = aB . WB
If aA = aB ==> WA = WB
By the same token:
If the labor in Country A is twice as productive as the
labor in Country B, then:
2aA = aB  WA = 2 WB
Trade and Factor Prices in a
Ricardian World
In a Ricardian world where relative prices are
determined by the (relative) labor content of each
unit of a good, and trade is driven by relative
price differentials (comparative advantage), after
trade, the higher relative price of the good a
country specializes in would result in higher
(real) wages for all. Therefore, one would expect
free trade to be supported by all.
A Two-Factor H-O World
In each country:
L = aLX . X + aLY . Y
K = aKX .X + aKY Y
Recall: aL = 1/MPL ; aK = 1/MPK
For any traded good:
Assuming fixed proportion production functions for both goods
we write:
(P)A = MC = aLXA . W + aKXA . r
(P)B = MC = aLXB . W + aKXB . r
A simple demonstration:
Consider a country with capital and labor producing X and Y
where Px = Py = 2; Px/Py = 2/2 = 1
Px = w + r; (K/L)x = 1
Py = 0.5 w + 1.5 r ; (K/L)y = 3
Note that X is relatively more labor intensive
Solving
2 = w + r and 2 = 0.5 w + 1.5 r for w and r, we’ll get:
w = r = 1; w/r = 1
Now suppose Px =2.2 (A 10% increase in the price of X)
This time we solve 2.2 = w + r and 2 = 0.5 w + 1.5 r for w and r.
we’ll get: w = 1.30 (30% increase in wage); r = 0.90 (10% reduction)
Now:
w/r = 1.30/0.90 = 1.44 (44% increase)
Starting with K and L and goods X and Y:
Where (Px/Py)A < (Px/Py)B ; WA < WB ; rA >rB
Note that Country A is labor-abundant
Good X is labor intensive
After trade: (Px/Py)A ; (Px/Py)B
Demand for labor in A will increase while the
production tends toward X and away from Y
In A wage, WA, will increase while rA will go down
In B wage, WB, will decrease while rB will go up
 (Px/Py)A = (Px/Py)B = tt
WA = WB ; rA = rB
In each country:
• As w/r ration changes, changing the slope of the
isoquant, the K/L ratio changes
Qx
K
(K/L)1
MRTS = MPL/MPK= w/r
(K/L)o
-(w/r)1
-(w/r)o
o
L
Trade as an Alternative to Factor Movements
Note: assuming the basic assumptions of the H-O model
hold, still complete output price equalization may not
occur due to transportation costs, barriers to trade, and
existence of goods that are rarely traded.
Yet, the factor price equalization theorem suggests an
important policy alternative:Allow free trade in outputs,
specialize in labor-intensive production, and export labor
indirectly in the form of labor-intensive goods.
In recent years countries such as Ireland, the Philippines,
India, Jamaica, and Bangladesh, China, and Malaysia have
been doing just just that.
Factor Immobility
• So far we have been assuming that factors are
completely mobile among industries within a
country and completely immobile among
countries.
• At least in the short run within each country the
mobility of factors may be imperfect. Thus, the
short-run effects of (free) trade may not be the
same long-run effects explained by StolperSamuelson and factor price equalization theorem.
The Case of Short-Run Labor Immobility
Wage
Rug Inds
Wage
Comp.Inds
w1
w2
w2
wo
wo
DLR1: VMPLR1
DLRo: VMPLRo
DLC: VMPLC
o
Rug Labor
Total Labor
Recall that in factor markets
Wage = w = MPL . Price = Value of Marginal Product of Labor
(The demand for labor originates from this equation)
Likewise,
Capital rent = r = MPK . Price = Value of Marginal Product of Capital
(The demand for capital originates from this equation.)
An increase in the price (of a good) would make demand for the input
used in the production (of that good) increase (shift).
The Effect of Price on factor prices
when one of the Factors is Immobile
Assuming labor is mobile but capital is immobile,
wage rates rise in both industries, but by
proportionally less than the price of shoes.
– The effect on workers’ purchasing power depends on shares
of shoes and computers in workers’ consumption baskets.
• The return to shoe capital rises more than the price of shoes, so
owners of shoe capital enjoy an increase in buying power
regardless of their pattern of consumption.
• Return to computer capital falls, so those owners suffer a loss of
purchasing power regardless of their pattern of consumption
Mobile Labor Immobile Capital: The
Case of a Capital- Abundant Country
Country (say US) has a comparative disadvantage in
( labor-intensive) rug production and comparative
advantage in (capital-intensive) computer production. It
opens trade with another country.
• The price of computers would rise; the price rugs would fall
• Rug production would fall and computer production would rise
» Wages would fall (probably less than proportionally with the
price of rugs); the net effect on real wages depends on the
combination of rugs and computers workers purchase
» The price of computer-specific capital will increase
proportionally more than the price of computers; rc/Pc would
go up; rC/PR would go up as well
» The price of rug-specific capital will fall; the purchasing power
of rug-specific capital would fall
In the long run, when capital and labor are both
mobile, in the Capital abundant country :
• The rate of return on capital (in both
industries) would increase
• The purchasing power of rate of return on
capital would increase; there would be a
magnification effect
• Wages (in both industries) would decline
• The purchasing power of workers would
decline; there would be a magnification effect
Factor Immobility and Adjustment
Costs
• In any factor endowment models there losers and
there winners
• When there is factor immobility the distribution
of the gains from trade tend to be more skewed
• Generally we expect the gains from trade to
exceed is losses
• The Pareto Criterion
Pareto Criterion
• If additional goods were distributed such that at
least one person would end up with more while
others’ access to the goods would remain
unchanged, then you could say that trade
increased the welfare or utility of society and
“the gains from trade” met Pareto Criterion.
• Pareto criterion: Any change that makes at
least one person better off without making any
other person worse off increases (societal)
welfare
Can Free Trade Produce a ParetoOptimal Outcome?
• Losers in the short run include the owners
of industry-specific factors used in the
country’s comparatively-disadvantaged
industry
• Losers in the long run include owners of
(scarce) factor used in the country’s
comparatively-disadvantaged industry
intensively
Adjustment Mechanisms and
Adjustment Costs
• Take from the winners; give to the losers
• Trade Adjustment Assistance (TAA)
• The Trade Act of 1974
• OTCA of 1988
• Helping the “losers” without retarding the
adjustment process
• The effects of international factor mobility