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3 Gains and Losses from Trade in the Specific-Factors Model
1. In the chapter, we learned that workers displaced by import competition are eligible for
compensation through the Trade Adjustment Assistance program. Firms are also eligible
for support through Trade Adjustment Assistance for Firms, a federal program that
provides financial assistance to manufacturers affected by import competition. Go to
http://www.taacenters.org to read about this program, then answer the following:
a. Describe the criteria a firm has to meet to qualify for benefits.
Answer: According to the website,
manufacturers
are
qualified
to receive ben
efits
from
b. What amount of money is provided to firms, and for what purpose? Describe one of
the “success stories,” in which a firm used financial assistance to improve its
performance.
Answer: Under the “50/50 cost
sharing”
program, the TAA
pays
up to $75,000 for
c. Provide an argument for and an argument against the continued funding of this federal
program.
Answer: Opponents of TAA would argue that the program
is
costly. The following
2. Why is the specific-factors model referred to as a short-run model?
3. Figure 3-7 presents wages in the manufacturing and services sectors for the period 1974 to
2014. Is the difference in wages across sectors consistent with either the Ricardian model
studied in Chapter 2 or the specific-factors model? Explain why or why not.
4. In the gains from trade diagram in Figure 3-3, suppose that instead of having a rise in the
relative price of manufactures, there is a fall in that relative price.
a. Starting at the no-trade point A in Figure 3-3, show what would happen to production and
consumption.
Answer:
As seen in this diagram, a fall in the relative price of manufactures is shown by the
b. Which good is exported and which is imported?
Answer: The decrease in the relative price of manufactures in the trade equilibrium
c. Explain why the overall gains from trade are still positive.
Answer: Overall gains from trade are still positive because the country is able to sell
5. Starting from equilibrium in the specific-factors model, suppose the price of manufactured
goods falls so that wages fall from W
′
to W in Figure 3-5.
a. Show that the percentage fall in the wage is less than the percentage fall in the price of
manufacturing so that the real wage of labor in terms of manufactured goods goes up.
Answer:
As seen in the diagram, both the price of manufactured goods and the wages decrease.
The key to this exercise is to realize that the vertical distance of the decrease in wage is
b. What happens to the real wage of labor in terms of agriculture?
c. Are workers better off, worse off, or is the outcome ambiguous?
Answer: Because the real wage increases with respect to manufactured goods and
decreases with respect to agriculture, the outcome will be ambiguous for workers. For
Work It Out
Use the following information to answer the questions below:
Manufacturing: Sales revenue = PM · QM = 150
Payments to labor = W · LM = 100
Payments to capital = RK · K = 50
Agriculture: Sales revenue = PA · QA = 150
Holding the price of manufacturing constant, suppose the increase in the price of agriculture
is 20% and the increase in the wage is 10%.
a. Determine the impact of the increase in the price of agriculture on the rental on land and
the rental on capital.
Answer: Rental on land can be calculated as follows:
T
R
100
Recalling that the price of manufacturing remained constant, we get the rental on capital
as
K
R
50
b. Explain what has happened to the real rental on land and the real rental on capital.
Answer: Because of the 20% increase in the price of agriculture, the real rental on land
rose, whereas the real rental on capital fell. Therefore, landowners are better off because
Change in the real
Real rental on Real rental
wage is ambigous
capital falls on land rises
KK A TT
6. If, instead of the situation given in the Work It Out problem, the price of manufacturing were
to fall by 20%, would landowners or capital owners be better off? Explain. How would the
decrease in the price of manufacturing affect labor? Explain.
Answer: Capital owners would be worse off since the decrease in rental on capital (40%) is
greater than the drop in the price of manufacturing (20%). Landowners would be better off in
K
R
100
although the rental on land is
∆RT =
T
LWQ AA ⋅∆−⋅0
T
R∆
⋅
∆
LW
W
A
T
R
100
Putting it together we get
7. Read the article by Grant Aldonas, Robert Lawrence, and Matthew Slaughter, available
online at: https://www.hks.harvard.edu/fs/rlawrence/fsf_adjustment_assistance_plan.pdf.
Then answer the following questions.
a. What is the name of the new program that these authors propose, and from what three
programs in the United State would it combine elements?
Answer: The authors propose the Adjustment Assistance Program (APP), which
b. What is the authors’ specific proposal for wage-loss insurance?
Answer: They propose the immediate adoption of similar new wage-loss insurance
c. What is their specific proposal for health insurance?
d. What is their specific proposal for giving workers access to savings?
e. Would the program they propose depend on a worker losing his or her job because of
trade competition or a shift of production facilities overseas?
f. What would their proposed program cost annually, and how does that compare with the
annual cost of the Trade Adjustment Assistance program?
8. In the specific-factors model, assume that the price of agricultural goods decreases while the
price of manufactured goods is unchanged (ΔPA/PA < 0 and ∆PM/PM = 0). Arrange the
following terms in ascending order:
∆RT/RT ∆RK/RK ∆PA/PA ∆PM/PM ∆W/W
Hint: Try starting with a diagram like Figure 3-5, but change the price of agricultural goods
instead.
Answer: It helps to separate this exercise into two parts. The first part is to arrange the
percentage changes in wages and goods prices. This part is similar to problem 4 except that
9. Suppose two countries, Canada and Mexico, produce two goods: timber and televisions.
Assume that land is specific to timber, capital is specific to televisions, and labor is free to
move between the two industries. When Canada and Mexico engage in free trade, the relative
price of televisions falls in Canada and the relative price of timber falls in Mexico.
a. In a graph similar to Figure 3-5, show how the wage changes in Canada due to a fall in
the price of televisions, holding constant the price of timber. Can we predict that change
in the real wage?
b. What is the impact of opening trade on the rentals on capital and land in Canada? Can we
predict that change in the real rentals on capital and land?
Answer: Because capital is specific to the television sector, the drop in the relative price
c. What is the impact of opening trade on the rentals on capital and land in Mexico? Can we
predict that change in the real rentals on capital and land?
d. In each country, has the specific factor in the export industry gained or lost and has the
specific factor in the import industry gained or lost?
10. Home produces two goods, computers and wheat, for which capital is specific to computers,
land is specific to wheat, and labor is mobile between the two industries. Home has 100
workers and 100 units of capital but only 10 units of land.
a. Draw a graph similar to Figure 3-1 with the output of wheat on the vertical axis and the
labor in wheat on the horizontal axis. What is the relationship between the output of
wheat and the marginal product of labor in the wheat industry as more labor is used?
Answer: See the following graph.
b. Draw the production possibilities frontier for Home with wheat on the horizontal axis and
computers on the vertical axis.
Answer: See the following graph.
c. Explain how the price of wheat relative to computers is determined in the absence of
trade.
d. Reproduce Figure 3-4 with the amount of labor used in wheat, measuring from left to
right along the horizontal axis, and the amount of labor used in computers moving in the
reverse direction.
e. Assume that due to international trade, the price of wheat rises. Analyze the effect of the
increase in the price of wheat on the allocation of labor between the two sectors.
The increase in the price of wheat shifts the PW · MPLW curve upward to PW
′
· MPLW so
11. Similar to Home in Problem 10, Foreign also produces computers and wheat using capital,
which is specific to computers; land, which is specific to wheat; and labor, which is mobile
between the two sectors. Foreign has 100 workers and 100 units of land but only 10 units of
capital. It has the same production functions as Home.
a. Will the no-trade relative price of wheat be higher in Home or in Foreign? Explain why
you expect this outcome.
Answer: The no-trade relative price of wheat will be higher in Home than Foreign
The situation would be opposite for the foreign country, which has more land than
capital. In this case, the price of capital is higher relative to the price of wheat without
trade.
b. When trade is opened, what happens to the relative price of wheat in Foreign and to the
relative price of wheat in Home?
Answer: When the two countries engage in trade, Home will export computers, so the
c. Based on your answer to (b), predict the effect of opening trade on the rental on land in
each country, which is specific to wheat. What about the rental on capital, which is
specific to computers?
Answer: With Home exporting computers, the rental on capital will increase while the
