Specific Factors Model

Question 1

How can trade effect distribution of income

Answer 1

Resources cannot move immediately and free from one industry to another. (Like prev models predict)

Industries differ in factors of production they demand

Question 2

So role of specific factors model

Answer 2

Allows trade to affect income distribution

Question 3

Model build
2 goods X & Y
Labour homogenous and used in producing both goods
X needs specific capital K
Y needs specific capital T

Thus what are the production functions for X and Y, and total labour endowment

Answer 3

X =X(LX,K)
Y =Y(LY,T)

and total labour endowment is given by
LX + LY = L

Question 4

Production possibilities when labour shifts from one sector to the other e.g from Y to X

Answer 4

When labour moves from Y to X, production Y falls while output of X rises at a slowing rate.

Question 5

Production function for X diagram

Question 6

Four quadrant diagram for deriving the PPF

Question 7

Production possibilities frontier is curved because…

Question 8

Q

Question 9

How do we find how much labour is employed in each sector

Answer 9

By considering supply and demand e.g more demand in product, more demand labour

Question 10

Where do employers maximise profits
i.e demand for labour function in sectors X and Y

Answer 10

W = VMPLx
W = VMPLy

As labour is mobile, wages should be equal. If one wage was higher, workers move to that sector to equalise wages

Question 11

Demand for labour diagram (simple)

Answer 11

Downward sloping as wage falls as MPL falls (recall basic MPL schedule

Question 12

What if we increase the amount of the fixed factor? E.g giving more capital to labour

Answer 12

Shift upwards in demand for labour since MPL increases for that given amount of labour

(More capital to work with, higher K/L ratio)

Question 13

Equilibrium allocation of labour

Answer 13

Where 2 demand curves intersect gives the wage (since equal) , and intersection gives the allocation of labour between the 2 sectors X and Y

Question 14

Pg 11

Question 15

Q

Question 16

What if the prices of X and Y change, what happens to the allocation of labour and distribution of income?

Answer 16

Depends on whether RELATIVE prices change.

(Since if prices increase for both proportionally then relative prices remain constant so no effect, KEY TERM IS EQUI-PROPORTIONAL)

Question 17

Equi-proportional change diagram pg 14

Answer 17

Only shifts up in prices, causes wages to rise by same amount to, real incomes, output and allocation of labour stay the same

Question 18

Scenario 2: increase in price of X

Answer 18

Now relative price of X is more, only demand for labour for good X increases, so shift upwards.

Now labour allocation has changed: produces more X and less Y

But important: wages rise less than the price rise in X now e.g if X price rose by 10%, wages rise but dont rise by as much (whereas equi-proportional wages would rises by same amount)

Question 19

So who benefits and loses

Answer 19

Wage earners gain in terms of Y, lose in terms of X (since price of Y stays the same, but equilibrium wage has risen)

Owners of capital K (capital specific needed for good X) gain, since workers join to increase MPL (and prices have risen more than their wage costs)

Owners of capital T (specific capital needed for good Y) lose, since labour moves to X, so lower MPL now (since have to pay higher labour costs)

Question 20

General results for the relationship between returns to factors and prices, for a rise in Px is…

pg 17

Question 21

Effect of change in a specific factor on production e.g an increased endowment of T (specific capital used for good Y)

Answer 21

More specific factors for Y, so more workers within industry Y have more capital to work with, so labour productivity in Y increases, thus nominal incomes rise and output rises in Y

Output falls in the other sector

Question 22

An increased endowment of T (specific capital used for good Y)

Effect on returns?

Answer 22

Increased real returns to mobile factor (wages have risen, prices haven’t changed, so real wages (returns W/P only W rises) to the mobile factor have risen.

Decreased real returns to both specific factors (MPK and rK falls)

As for T, T increases and labour in sector Y increases (T/L , both T and L increase but workers get less productive as cannot offer them all the same wage, so T/L is higher, meaning MPT becomes less productive and rT falls)

Question 23

Now effect of increased endowment of L (the mobile factor)

How to draw on diagram

Answer 23

It will increase output of both sectors (will initially work in the sector with the higher wages, however they equalise hence why increases output for both)

B) extend horizontally, and shift right in curve

Question 24

Effect of increased endowment on L (mobile factor)

On returns

Answer 24

Decreased real returns to labour (wages fall as higher supply of labour, and less productive so MPL falls)

Increases real returns to both specific factors (since more labour per the capital MPK and MPT rise so rK and rT)

Question 25

Now for trade , assume country A has more of specific factor K (used for good X)

What does country A produce, and the price?

B)

Answer 25

Country A produces relatively more of good X than country B.

Thus relative price of good X is lower in country A

B) diagram

Question 26

In the specific factors model what will counties expor

Answer 26

Specialise and export the good they have a compatrativ advantage in

Question 27

Without trade what must happen to an economy’s output (hint: consumption)

Answer 27

Output of a good must equal its consumption (since none gets exported)

Trade allows this to not be true

Question 28

How can we express this idea that a country cannot spend more than it earns

B) how can we rearrange to make useful

Answer 28

PX · DX + PY · DY = PX · X + PY · Y

B) (Dy - Y) = (Px/Py) x (X - Dx)
Useful as shows a country imports an amount of Y relative to the relative price of X times amount of X exported

Question 29

Gains from trade in the SF model?

Answer 29

Yes, as economy consumes more, so on average better-off.

Eval:
Not every individual will be better off due to redistribution effects

Question 30

Key - when trade is open - relative prices converge

Question 31

If exam question is outline model

Answer 31

Assumptions
Implications under
A) autarky
B) free trade
C) gains from trade & sources of gains from trade e.g sources of gains could be from exchange, specialisation, or consumers being able to consume a variety
Finally outline Criticisms

E.g HO has 2 FOP so concave PPF i.e DMR