4.1. Specific Factors Model Flashcards
Assumptions of the specific factors model
The economy produces two goods, cloth and food.
The economy has three factors of prouduction:
- Cloth is produced using labour and capital.
- Food is produced using labour and land.
Labour is therefore mobile, while capital and land are both specific factors that can only be used to produce their specific goods.
Qc = Qc(K, Lc): production function of cloth.
Qf = Qf(T, Lf): production function of food.
Labour employed: Lc + Lf = L.
Production possibilities
Qc = Qc(K, Lc) can be visualised as a concave production function, with slope of marginal productivity of labour.
Experiences diminishing marginal productivity, as continuously increasing one factor on its own leads to less and less marginal product.
Similar graphs can be generated for the output of food.
Drawing the SFM PPF
The PPF is curved, as multiple factors of production cause curvature.
The curvature represents the diminishing marginal productivity.
Shifting one person-hour of labour from food -> cloth increases cloth output by MPLc and decreases food output by MPLf.
To gain one more unit of cloth, we need to increase labour by 1/MPLc.
To increase cloth output by one unit, the economy must reduce consumption by MPLf/MPLc.
Opportunity cost and marginal productivity of labour
The MPLc and MPLf can be used to represent the opportunity cost.
-MPLf / MPLc = aLC / aLF.
But:
- As Lc rises, MPLc falls.
- As Lf falls, MPLf rises.
As labour is moved from food to cloth, each additional unit of labour becomes less valuable in cloth and more valuable in food.
The opportunity cost of each additional unit of cloth rises and the PPF gets steeper as we move down to the right as (MPLf increases) / (MPLc decreases)
Labour allocation
Demand for labour depends on price of output and the wage rate.
Employers will maximise profits by demanding labour up to the point where the value produced by an additional unit equals the marginal cost of employing the worker for that hour.
The value of an additional person hour equals Pc * MPLc or Pf * MPLf.
These equal the wages.
Labour demand curves
As MPL slopes downwards, for any given value of Px, the value of MPLx * Px will slope downwards.
Therefore, as more employees are taken on, the wage rate falls as MPL decreases. Employers want to hire more and more workers.
In the absence of trade, the wage rate must be equal in both sectors to ensure labour is mobile.
Pc * MPLc = Pf * MPLf = w.
-MPLf / MPLc = -Pc / Pf.
The slope of the PPF is equal to the negative relative price of cloth. The economy produces at this point.
The wage is therefore set equal.
