Homework 3

UCDavis, 160a, Winter 2008 Prof. Farshid Mojaver

The Specific Factors Model and Factor Movement 1. Suppose that there are three factors: Capital, Labor, and Land. Bread requires inputs of land and labor, while steel requires capital and labor. a. Which factors are mobile and which are specific? b. Assume that Canada’s endowments of land and capital are 10 units of capital and

100 land, while the U.S.’s are 50 units of capital and 100 land. Which good does each country export? Why?

c. How does trade affect the returns to land, labor, and capital in the U.S. and in Canada? (Be sure to provide the details on whose real incomes go up or down, which prices go up or down in which countries, and, if the effects are indeterminate, then explain why.)

2. In the specific factors model, again suppose that the relative price of manufactured goods decreases. That is, assume that the price of agricultural goods increases while the price of manufactured goods is unchanged (i.e. ΔPA/PA > 0 and ΔPM/PM = 0). Arrange the following terms in ascending order:

ΔRT/RT ΔRK/RK ΔPA/PA ΔPM/PM ΔW/W

3. Make an argument that a) there is tendency for labor to migrate from the rest of the world to USb) migration improves US GDP but lowers the GDP of the ROWc) migration is beneficial for the migrants but huts workers in the host countryd) owners of land/capital in the host country are better of as a result of labor

migratione) the world as a whole is better as a result of migration

4. In the specific factors model for manufacturing goods and agriculture, consider a decrease in the stock of land. For example, suppose natural disaster decreases the quantity of arable land for planting crops.

a) Redraw Figure 5.12 starting from the initial equilibrium point A.b) What is the effect of this change on the quantity of labor in each industry and on

the equilibrium wage?c) Now suppose that international community wants to help the country struck by

the natural disaster and decides to do so by increasing its level of FDI. That is, the rest of the world increases its investment in physical capital in the stricken country. What is the effect of this policy on the equilibrium wage? What is the total effect on the equilibrium wage of the disaster and subsequent FDI investment (Increase, decrease or ambiguous)? Does the agriculture industry benefit or lose from the FDI?

5. Now consider a long-run model for a country producing 2 products (digital cameras and baskets) using 2 factors (capital and labor).

a) Which good would you expect to be capital-intensive? Which good would you expect to be labor-intensive? Why?

b) Suppose that foreign owners of domestic capital decide to decrease their investment. Illustrate the effects of this change in a box diagram. Does output in each industry increase, decrease or stay the same? Do wages increase, decrease, or stay the same in each industry?

6. Figure 5.14 is a supply and demand diagram for the world labor market. Consider a situation where Foreign workers immigrate to the home country, causing the Home wage to decrease to WNEW > W’, and where the Foreign wage begins at W* and increases to WNEW > W’.

a) Is this a stable outcome in the long run? That is, would you expect this pattern of immigration to stay the same, to reverse, or to stop at the new Home and Foreign wages?

b) Going from old wages to the new, are there gains that accrue to the Home country? Are there gains that accrue to the Foreign country? If so, redraw the graph and identify the magnitude of the gains for each country. If not, say why not.