Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
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
International Trade in the Specific Factors Model
Income Distribution and the Gains from Trade
The Political Economy of Trade: A Preliminary View
Income Distribution and Trade Politics
Case Study: Trade and Unemployment
International Labor Mobility
Case Study: Wage Convergence in the Age of Mass Migration
Case Study: Foreign Workers: The Story of the GCC
Summary
APPENDIX TO CHAPTER 4: Further Details on Specific Factors
Marginal and Total Product
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.
The Specific Factors model assumes that there is one factor that is mobile between sectors (commonly
thought of as labor) and production factors that are specific to each sector. The chapter begins with a simple
economy producing two goods: cloth and food. Cloth is produced using labor and its specific factor, capital.
14 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
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.
As we assume that labor is perfectly mobile between industries, the wage rate must be identical between
industries. With competitive labor markets, the wage must be equal to the price of each good times the
marginal product of labor in that sector. We can use the common wage rate to show that the economy will
produce a mix of goods such that the relative price of one good in terms of the other is equal to the relative
cost of that good in terms of the other. Thus, an increase in the relative price of one good will cause the
economy to shift its production toward that good.
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.
Suppose that after trade, the relative price of cloth increases by 10 percent. As a result, the country will
increase production of cloth. This will lead to a less than 10 percent increase in the wage rate because
some workers will move from the food to the cloth industry. The real wage paid to workers in terms of
cloth (w/PC) will fall, while the real wage paid in terms of food (w/PF) will rise. The net welfare effect for
labor is ambiguous and depends on relative preferences for cloth and food. Owners of capital will
unambiguously gain because they pay their workers a lower real wage, while owners of land will
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.
presidential elections and a major producer of both steel and tires, is used as an example to illustrate this
point with both Presidents Bush and Obama supporting tariffs on steel and tires, respectively.
Although the losers from trade are often able to successfully lobby for protectionism, the chapter
highlights three reasons why this is an inefficient method of limiting the losses from trade. First, the actual
impact of trade on unemployment is fairly low, with estimates of only 2.5 percent of unemployment
directly attributable to international trade. Second, the losses from trade are driven by one industry
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
countries. Workers will migrate from low-wage countries to high-wage countries. As a result, wages in the
low-wage countries will rise, and those in the high-wage countries will fall. Though the net effect of free
migration is positive, there will be both winners and losers from migration. Workers who stayed behind in
◼ Answers to Textbook Problems
1. A country would opt for international trade even though the workers in the import competitive
sector face the risk of losing their jobs. This is mainly because if the gains that the consumer realizes
if more imports were allowed and the associated increase in employment in the export sectors.
Under perfect labor mobility, if the real wage in Thailand is higher than Bangladesh, then labor
2. a.
16 Krugman/Obstfeld/Melitz • International Economics: Theory & Policy, Tenth Edition
b.
The curve in the PPF reflects diminishing returns to labor. As production of Q1 increases, the
opportunity cost of producing an additional unit of Q1 will rise. Basically, as you increase the
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 competitive labor markets, the wage is equal to price times the marginal product of labor. With
mobile labor between sectors, the wage rate must be equal between sectors. Thus, the equilibrium
Chapter 4 Specific Factors and Income Distribution 17
b. From part (a), we know that 30 units of labor are employed in Sector 1 and 70 units of labor are
employed in Sector 2. Looking at the table in Question 2, we see that these labor allocations will
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.
The decrease in the price of good 2 leads to an increase in the share of labor accruing to Sector 1.
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.
b. Given the increased production possibility for Home, the relative supply of home (defined as
Q1/Q2) is further to the right than the relative supply for Foreign. As a result, the relative price of
good 1 is lower in Home than it is in Foreign.
c. If both countries open to trade, Home will export good 1, and Foreign will export good 2.
d. Owners of capital in Home and owners of land in Foreign will benefit from trade, while owners of
land in Home and owners of capital in Foreign will be hurt. The effects on labor will be ambiguous
because the real wage in terms of good 1 will fall (rise) in Home (Foreign) and the real wage in
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.
b. Landowners in Foreign benefit as their costs fall by 2 for each worker employed.
7. If the price of wheat increases by 10%, then the labor demand in the wheat sector would increase by
the same 10 percent. In other words, the curve defined by MPLw × Pw would increase by 10 percent.
