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Unformatted text preview: Econ/EEP 181: International Trade Assignment # 2 Solutions Luosha Du, Shanthi Nataraj, and Robert Santillano University of California, Berkeley Due: October 1, 2008 1. Specific Factors and Trade. Finland is capital abundant relative to potential trading partners in the rest of the world. Telecommunications is a capital intensive sector relative to the business services sector. Businesses in Finland have made investment in both industries, creating stocks of capital that are devoted to either telecommunications or business services. The mobile factor of production in labor. (a) Suppose that Finland is not trading. Draw the specific factors diagram for Finland, indicating how labor is divided between the two industries, and showing the prevailing wage w o . Figure 1: Domestic Labor Market 6 6 w P T · MPL T P 1 T · MPL T P B · MPL B % ↑ w w 1 L T-→ ←- L B L L 1 Let us begin by listing all of the products and factors in this model: T =telecommunications sector B =business services sector K T =capital specific to telecom sector K B =capital specific to business services sector L =labor, mobile between industries P T = price of 1 units of telecom services P B =price of 1 unit of business services r t =rate of return on capital in telecom sector r b =rate of return on capital in business services sector w =wage rate of labor Figure 1 shows how labor is divided between the two industries. Labor is paid according to the value of the marginal product of labor (VMPL), which is equal to P T MPL T in the telecom 1 sector and P B MPL B in the business services sector. Since labor is mobile between sectors, and there is no unemployment, the intersection of these two curves tells us the allocation of labor in each sector, and the equilibrium wage rate w , as shown above. The labor to the left of L is in the telecom sector, while the labor to the right of L is in the business services sector. (b) Modify your diagram to show how Finland’s labor allocation and wage change when it opens trade with the rest of the world. To answer this question, we need to know what will happen to relative output prices after Finland allows trade. Since Finland is capital–abundant relative to its trading partners, and telecoms are relatively capital-intensive, Finland’s relative supply curve of telecom services to business services must be shifted to the right relative to its trading partners (it’s willing to provide more telecom services at any given price than its trading partners are). Therefore, when Finland opens up to trade, the relative price of telecom services will rise. For simplicity, we will assume that P B is unchanged and P T rises. This means that P T MPL T shifts up, as shown in Figure 1, so the equilibrium wage rises, and workers move out of the business sector into the telecom sector....
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This note was uploaded on 10/17/2008 for the course ECON 181 taught by Professor Kasa during the Fall '07 term at Berkeley.
- Fall '07
- Monetary Policy