Chapter 4
Specific Factors and Income Distribution
◼ Chapter Organization
The Specific Factors Model
Box: What Is a Specific Factor?
Assumptions of the Model
Production Possibilities
Prices, Wages, and Labor Allocation
Relative Prices and the Distribution of Income
◼ Chapter Overview
In Chapter 3, the Ricardian model of trade was introduced with labor as the single factor of production
exhibiting constant returns to scale. Although informative, this model fails to highlight the observed
opposition to free trade. In this chapter, the Specific Factors model is presented to gain a better
understanding of the distributional effects of trade. After trade, the exporting industry expands, while the
import competing industry shrinks. As a result, the factor specific to the exporting industry gains from
trade, while the factor specific to the import competing industry loses from trade. However, the aggregate
gains from trade are greater than the losses.
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Food is produced using labor and its specific factor, land. Given that capital and labor are specific to their
respective industries, the mix of goods produced by a country is determined by share of labor employed in
each industry. The key difference between the Ricardian model and the Specific Factors model is that in the
latter, there are diminishing returns to labor. For example, production of food will increase as labor is added,
but given a fixed amount of land, each additional worker will add less and less to food production.
With international trade, the country will export the good whose relative price is below the world relative
price. The world relative price may differ from the domestic price before trade for two reasons. First, as in
the Ricardian model, countries differ in their production technologies. Second, countries differ in terms of
their endowments of the factors specific to each industry. After trade, the domestic relative price will equal
the world relative price. As a result, the relative price in the exporting sector will rise, and the relative
price in the import competing sector will fall. This will lead to an expansion in the export sector and a
contraction of the import competing sector.
Given these positive net welfare effects, why is there such opposition to free trade? To answer this question,
the chapter looks at the political economy of protectionism. The basic intuition is that the though the total
gains exceed the losses from trade, the losses from trade tend to be concentrated, while the gains are diffused.
Import tariffs on sugar in the United States are used to illustrate this dynamic. It is estimated that sugar tariffs
cost the average person $7 per year. Added up across all people, this is a very large loss from protectionism,
but the individual losses are not large enough to induce people to lobby for an end to these tariffs. However,
the gains from protectionism are concentrated among a small number of sugar producers, who are able to
effectively coordinate and lobby for continued protection. When the losses from trade are concentrated
among politically influential groups, import tariffs are likely to be seen. Ohio, a key swing state in U.S.
Chapter 4 Specific Factors and Income Distribution 15
trade—by redistributing the gains from trade in the form of safety nets for those temporarily unemployed
and worker retraining programs to ease the transition from import competing to export sectors—than it is
to limit trade to protect existing jobs.
Finally, the chapter uses the framework of the Specific Factors model to analyze the distributional effects
of international labor migration. With free migration of labor across borders, wages must equalize among
◼ Answers to Textbook Problems
1. Texas and Louisiana are both oil-producing states. A decrease in the price of oil will reduce output in
these two states, hurting owners of capital and workers in the oil industry. Although some capital will
2. a.
16 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
b.
3. a. Draw the marginal product of labor times the price for each sector given that the total labor
allocated between these sectors must sum to 100. Thus, if there are 10 workers employed in
Sector 1, then there are 90 workers employed in Sector 2. If there are 50 workers employed
in Sector 1, then there are 50 workers employed in Sector 2. For simplicity, define P1 = 1 and
P2 = 2 (it does not matter what the actual prices are in determining the allocation of labor, only
that the relative price P2/P1 = 2).
Chapter 4 Specific Factors and Income Distribution 17
c. If the relative price of good 2 falls to 1.3, we simply need to redraw the P MPL diagram with
P1 = 1 and P2 = 1.3.
−0.77.
d. The decrease in the relative price of good 2 led to an increase in production of good 1 and a
decrease in the production of good 2. The expansion of Sector 1 increases the income of the
18 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
4. a. The increase in the capital stock in Home will increase the possible production of good 1, but have
no effect on the production of good 2 because good 2 does not use capital in production. As a
result, the PPF shifts out to the right, representing the greater quantity of good 1 that Home can
now produce.
5. The real wage in Home is 10, while real wage in Foreign is 18. If there is free movement of labor, then
workers will migrate from Home to Foreign until the real wage is equal in each country. If 4 workers
move from Home to Foreign, then there will be 7 workers employed in each country, earning a real
wage of 14 in each country.
Chapter 4 Specific Factors and Income Distribution 19
6. If only 2 workers can move from Home to Foreign, there will be a real wage of 12 in Home and
a real wage of 16 in Foreign.
a. Workers in Foreign are hurt as their wage falls from 18 to 16.
e. The workers who do move benefit by seeing their wages rise from 10 to 16.
7. By restricting immigration, the drop in wages in the high-wage country is not as high as it would
have been had migration been open. By the same token, the increase in wages in the low-wage country