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relative demand curve intersects the vertical section of the relative supply curve. Thus the equilibrium relative price is 2.
c. Home produces only apples, Foreign produces only bananas, and each country trades some of its product for the product of the other country.
d. In the absence of trade, Home could gain three bananas by foregoing two apples, and Foreign could gain by one apple foregoing five bananas. Trade allows each country to trade two bananas for one apple. Home could then gain four bananas by foregoing two apples while Foreign could gain one apple by foregoing only two bananas. Each country is better off with trade.
4. The increase in the number of workers at Home shifts out the relative supply
schedule such that the corner points are at (1, 3/2) and (1, 5) instead of (1/2, 3/2)
and (1/2, 5). The intersection of the relative demand and relative supply curves is now in the lower horizontal section, at the point (2/3, 3/2). In this case, Foreign still gains from trade but the opportunity cost of bananas in terms of apples for Home is the same whether or not there is trade, so Home neither gains nor loses from trade.
5. This answer is identical to that in 3. The amount of \labor\has not
changed since the doubling of the labor force is accompanied by a halving of the
productivity of labor.
6. This statement is just an example of the pauper labor argument discussed in the
chapter. The point is that relative wage rates do not come out of thin air; they are determined by comparative productivity and the relative demand for goods. The box in the chapter provides data which shows the strong connection between wages and productivity. Korea's low wage presumably reflects the fact that Korea is less productive than the United States in most industries. As the test example illustrated, a highly productive country that trades with a less productive, low-wage country will raise, not lower, its standard of living.
7. The problem with this argument is that it does not use all the information
needed for determining comparative advantage in production: this calculation involves the four unit labor requirements (for both the industry and service sectors, not just the two for the service sector). It is not enough to compare only service's unit labor requirements. If als < als*, Home labor is more efficient than foreign labor in services. While this demonstrates that the United States has an absolute advantage in services, this is neither a necessary nor a sufficient
condition for determining comparative advantage. For this determination, the industry ratios are also required. The competitive advantage of any industry depends on both the relative productivities of the industries and the relative wages across industries.
8. While Japanese workers may earn the equivalent wages of U.S. workers, the
purchasing power of their income is one-third less. This implies that although w=w* (more or less), p 9. Gains from trade still exist in the presence of nontraded goods. The gains from trade decline as the share of nontraded goods increases. In other words, the higher the portion of goods which do not enter international marketplace, the lower the potential gains from trade. If transport costs were high enough so that no goods were traded then, obviously, there would be no gains from trade. 10. The world relative supply curve in this case consists of a step function, with as many \with different unit labor requirement ratios. Any countries to the left of the intersection of the relative demand and relative supply curves export the good in which they have a comparative advantage relative to any country to the right of the intersection. If the intersection occurs in a horizontal portion then the country with that price ratio produces both goods. FURTHER READING Donald Davis. “Intraindustry Trade: A Heckscher-Ohlin-Ricardo Approach” (working paper, Harvard University). Rudiger Dornbusch, Stanley Fischer, and Paul Samuelson. \Trade and Payments in a Ricardian Model with a Continuum of Goods.\American Economic Review 67 (December 1977) pp.823-839. Giovanni Dosi, Keith Pavitt, and Luc Soete. The Economics of Technical Change and International Trade. Brighton: Wheatsheaf, 1988. G.D.A. MacDougall. \and American Exports: A Study Suggested by the Theory of Comparative Costs.\Economic Journal 61 (September 1952) pp.487-521. John Stuart Mill. Principles of Political Economy. London: Longmans Green, 1917. David Ricardo. The Principles of Political Economy and Taxation. Homewood Illinois: Irwin, 1963. CHAPTER 3 SPECIFIC FACTORS AND INCOME DISTRIBUTION Chapter Organization The Specific Factors Model Assumptions of the Model Box: What is a Specific Factor? Production Possibilities Prices, Wages, and Labor Allocation Relative Prices and the Distribution of Income International Trade in the Specific Factors Model Resources and Relative Supply Trade and Relative Prices The Pattern of Trade Income Distribution and the Gains From Trade The Political Economy of Trade: A Preliminary View Optimal Trade Policy Box: Specific Factors and the Beginnings of Trade Theory Income Distribution and Trade Politics Summary Appendix: Further Details on Specific Factors Marginal and Total Product Relative Prices and the Distribution of Income CHAPTER OVERVIEW The analysis presented in the previous chapter, demonstrating unambiguous gains from trade, may leave students wondering why free trade is such a politically charged issue and why protectionism is so heatedly discussed in the press. The reason for this is that the debates concerning free trade focus on its distributional rather than its efficiency effects. A formal examination of these effects requires a model which has factors of production linked to producing certain goods. Two models of this nature are presented in this chapter. The first model includes factors of production which are inexorably tied to producing one and only one good. The particular example presented in the text involves winemakers and cheesemakers. The immobility of labor prevents equalization of wages. The production possibility frontier of this economy is a rectangle and the relative supply curve is a vertical line. An equilibrium relative price can be determined when the relative demand curve is specified. Consider the effect of introducing another country which can produce the same bundle of goods. The second economy shares the same production technology, but has different relative amounts of each type of labor. Trade between these two economies benefits each in the aggregate since the possible consumption set of each country expands. However, distributional issues arise when trade is permitted since workers in particular sectors may not gain from trade. There will be no gain for the labor in each economy which was relatively scarce prior to trade as compared to after trade. The type of labor relatively abundant in a country will gain from trade. The source of this effect is the movement in relative prices which favors the good which was relatively abundant in each country before trade. The general outcome is that trade benefits workers in the export sector of each country and hurts workers in the import-competing sector. Next, a more general model is presented to investigate the distributional effects of trade. This specific factors model allows an examination of the distributional effects of trade on factors inexorably tied to the production of a specific good as well as on a factor that can be used to produce either good. The three factors in this model include two specific factors, land and capital, as well as one inter-sectorally mobile factor, labor. The fixed amount of each specific factor results in diminishing returns to labor. The mobility of labor ensures an equal wage in the production of either good, and perfect competition ensures that the wage equals the value marginal product of labor in the production of each good. A graphical analysis demonstrates the distribution of labor between sectors as well as the return to labor. International trade alters the relative prices of goods and thus the amount of labor used in each sector, the real wage to labor and the returns to capital and land. The results of this model are similar to that of the immobile factors model in that owners of factors specific to export sectors in from trade while owners of factors specific to import sectors lose from trade. This model also shows that trade has an ambiguous effect on mobile factors. To reinforce the importance of these concepts,