International Trade and Factor Movements

Specific Factor Model

The question addressed by the specific-factors model is how trade, through changes in relative prices, affects the earnings of labor, land, and capital.

The specific-factors model introduces land and capital. The three factors are labor, land, and capital.

The specific factors model has 2 countries: Home & Foreign, 3 resources: labor, land, & capital, and 2 industries: manufacturing & agriculture.

The marginal product of labor declines as the amount of labor used in the industry increases, due to diminishing returns.

W = p(m) * mpl(m) or W = p(a) * mpl(a)

L(m) + L(a) = total labor

Immigration increases total labor causing wages to decrease

If one country has a cheaper manufacturing price, they have a comparative advantage in manufacturing.

By exporting manufactured goods at a higher price and importing food at a lower price, Home is better off than it was before.

If the price of a manufactured good goes up, the manufacturing labor goes up. Because of this, labor in the opposite sector (agriculture) goes down.

Revenue = p(m) * q(m)

Payment to capital = p(m) * q(m) – w * L(m)

Payment to land = p(a) * q(a) – w * L(a)

Earnings of capital r(k) = payments to capital / k

Earnings of land r(t) = payments to land / t

As more labor is used in manufacturing, the marginal product of capital will rise because each machine has more labor to work it

In addition, as labor leaves agriculture, the marginal product of land will fall because each acre of land has fewer laborers to work it

Heckscher-Ohlin Model

The specific factor model is short run because resources cannot move between industries

The Heckscher-Ohlin (H-O) Model is a long-run model because all resources can move between industries

The H-O Model assumes that trade occurs because countries have different resources

Each country has abundant/scarce factors of production to offer

Each product is either intensive or non-intensive in the use of a factor of production

This model tells you who should import & who should export

A country’s comparative advantage is determined by its initial resource endowments

Uses 2 countries, 2 goods, 2 factors of production

Comparative advantage = product intensive using abundant factor of production

Factor Price Equalization

Each country takes advantage of their comparative advantage at the same time.

Given the same technology and same world price for goods, factor prices converge across countries

Stolper-Samuelson Theorem

Free trade will increase income for relatively abundant factors of production in countries and decrease income for relatively scarce factors of production.

Immigration and Foreign Investment

Immigration Short Run Effects (Specific Factor Model)

Immigration benefits a country’s industries. These benefits are measured by payments to capital and land, called rentals.

If wages fall, leftover earnings of capital and land are more, so rentals are higher

As more labor is hired in each industry (because wages are lower), the marginal products of capital and land both increase. So, rentals on capital and land rise.

During immigration, an increase in labor at Home shifts the PPF curve outward and the output of both industries increases

Immigration Long Run Effects (H-O Model)

A higher capital-labor ratio, because of diminishing returns, means that the marginal product of capital AND real rental must be lower

More machines per worker means that the marginal product of labor (aka the real wage) is higher because each worker is more productive

Factor Price Insensitivity Theorem

States that in the H-O model with two goods and two factors, an increase in the amount of a factor found in an economy can be absorbed by changing the outputs of the industries, without any change in the factor prices.

Foreign Direct Investment

FDI occurs when a firm from one country owns a company in another country

Greenfield Investment: building of new plants abroad

FDI is a movement of capital between countries, just as we modeled the movement of labor between countries earlier

FDI Short Run Effects (Specific Factor Model)

An inflow of capital into the manufacturing sector shifts out the marginal product of the labor curve

(Effect of FDI on Wage) When equilibrium wages go up, more workers are drawn to the manufacturing industry

(Effect of FDI on Outputs) Since labor is removed from the agriculture sector, the output of that sector goes down and the manufacturing sector goes up

(Effect of FDI on Land Rentals) Because of FDI, fewer workers are employed by agriculture and each acre of land is not used as intensively

The value of the marginal product of land falls, so land rental falls

(Effect of FDI on Capital Rentals)

FDI Long Run Effects (H-O Model)

An increase in capital will increase the output of the capital-intensive industry and reduce the output of the labor-intensive industry.

This change in output is achieved without changing the capital-labor ratios in either industry

Because capital-labor ratios are unchanged, wage and the rental on capital are also unchanged

In the long-run model, an inflow of ANY factor of production will leave factor prices unchanged


Immigration benefits the host country in the specific factors model

If we include the immigrant earnings with Foreign income, then we find that emigration benefits the Foreign country, too. The same argument can be made for FDI

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