Lectures5n6 - The Specific Factors Model: A model with...

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The Specific Factors Model: A model with winners and losers Lectures 5 and 6 Chapter 3 of Feenstra and Taylor
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Outline The Home Country Production Possibilities Frontier Opportunity Cost and Prices The Foreign Country Country aggregate gains from trade Earnings of labor Effect on nominal and real wage Earnings of Capital and Land Determining the Payments to Capital and Land Change in the Real Rental on Capital Change in the Real Rental on Land
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Specific-Factors Model Two countries: Home and Foreign. Two goods: Manufacturing uses labor and capital. Capital is a specific/fixed factor in manufacturing Agriculture uses labor and land. Land is a specific/fixed factor in agriculture. Diminishing returns to labor – decreasing MPL M and MPL A . Countries have fixed supplies of capital, land and labor.
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Diminishing Marginal Product of Labor Figure 3.2
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Production Possibilities Frontier. Each country faces a standard Concave to the origin because of diminishing returns to labor in both industries. Go over the case of moving one unit of labor from Agriculture to Manufacturing. Complement the exercise with the graphs of Total Product of labor (as in the text). The slope of the PPF is the negative of the ratio of the marginal products The slope is the opportunity cost of producing one unit of manufacturing.
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Production Possibilities Frontier Figure 3.3
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Equilibrium in labor markets Firms equate the marginal cost of hiring a worker with the value of the marginal product. A A M M MPL P W MPL P W = =
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Specific-Factors Model Since labor is mobile, wages in the two industries must be equal. Relative price of manufacturing equals the opportunity cost of manufacturing (slope of PPF). M A A M A A M M PML PML P P PML P MPL P = =
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No trade (autarky) equilibrium The no-trade position for Home is shown on the next slide at point A In equilibrium – P M /P A = −(slope of PPF) = −(slope of indifference curve) The indifference curve is tangent to PPF
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No trade (autarky) equilibrium: Home U 1 Manufacturing Output, Q M A B Agriculture Output, Q A PPF Slope = –(P M /P A )
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International Trade The Foreign Country Assume the no-trade prices are such Home has comparative advantage in manufacturing (P M */P A *)> (P M /P A ). Home can produce at lower opportunity cost than Foreign country.
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Overall Gains from Trade When trade opens the world price will end up between the no-trade prices of the Home and Foreign countries. After trade Relative Home price of manufacturing will rise Relative Foreign price of manufacturing will fall Total gains from trade can be measured by the increased utility of the higher indifference curve
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Home Country with Trade Slope = –(P M /P A ) W U 1 Manufacturing Output, Q M A B Agriculture Output, Q A PPF Slope = –(P M /P A ) C U 2 Gains from trade The gains from trade can be measured by the rise in utility
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This note was uploaded on 04/06/2010 for the course FIN 305W at Pennsylvania State University, University Park.

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Lectures5n6 - The Specific Factors Model: A model with...

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