Lecture 6 International Trade Theory 1/2008 The Specific Factor Model Kornkarun Kungpanidchakul, Ph.D

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1 Leture 6 International Trade Theory 1/2008 The Seii Fator Model Kornkarun Kunganidhakul, Ph.D The seii ator model is one o the attemt to imrove the Heksher- Ohlin model by removing the assumtion that both ators are eretly mobile beteen the to industries. Why bother? - Some eole are against ree trade. Why? Seii ator model ill have the situation in hih some grous o eole are against ree trade, unlike the Riardian model. In the Riardian model, e have only one grou o eole hih are labor. Thereore, gains rom trade are divided equally among all eole in the eonomy. But the situation ill be dierent here. - Pattern o seialization under the Riardian model is extreme. - Allo or a more realisti set o ators. In the Heksher Ohlin model, e assume that all ators an be moved reely aross industries. Hoever, this kind o situation is suitable or the long run situation only. Consider one e install mahine to rodue ars, it is hard to believe that e an remove and reinstall that mahine to rodue stereos. Thereore, there are some ators hih are seii in the sense that it an be used in one industry only. This is the haraterization o the seii ator model. Assumtions - to goods: ish and his - CRS tehnology - Diminishing marginal roduts - Three ators, L is mobile; E and K are seii ators The rodution untion an be ritten as ollos: = ( E, L ) = gkl (, ) E = E K = K L + L = L There are three inome grous in this soiety and eah ill be aeted by trade dierently. Autarky and Comarative Advantage What determines relative ries? The simle anser is rom relative suly and demand. Assume idential homotheti test. The relative demand omes diretly rom the reresentative agent s utility maximization. While the relative suly omes rom the PPF.

2 Market Fores Still assume eret ometition in all markets. The roit maximization irms hire labors until VMPL = MPL = VMPL = MPL = Note that or given K,E, e have MPL alls ith an inrease in L. VMPL Labor market We no onsider the equilibrium ondition in the labor market. VMPL = MPL = = MPL L + L = L VMPL VMPL L * Labor in Labor in

3 No sine e kno that the equilibrium is suh that: MPL = MPL MPL = MPL Prie ratio = sloe o PPF Summary: - PPF relets tehnology and endoments - Sloe along PPF is the oortunity ost o ish in terms o his - Muh harder to get omlete seialization no omaring ith the Riardian model. - The eonomy oerates at the oint here: MPL = MPL The eet o a hange in endoment Reall Rybzynski theorem hih demonstrates that under onstant ommodity rie, an inrease in a artiular ator raises the outut o the good intensive in that ator and loers the outut o the other good. No let onsider the eet o a hange in endoment on the seii ator model. A. Groth in aital (K) Reall: raising K raises the outut o ish or any L F = g( K2, L ) F = g( K1, L ) With K2 > K1. An inrease in K also raises the MPL o labor, then shit the VMPL to the right. So the eonomy ill rodue more ish and less his. L

4 VMPL VMPL VMPL * Labor in Labor in At the same rie level, the eonomy ants to rodue more ish than beore. So the relative suly urve shits out. Thereore, more aital loers the relative rie o good using aital. RS RS RD We an use the same logi to analyze the ase that there is a groth in the seii ator E to dra a onlusion that the eonomy ill rodue more his and less ish and the relative rie o his alls. Thereore, an inrease in the endoment o a seii ator inreases the outut o the good that uses that ator and loer the outut o the other good by ulling labor rom it. This is similar to the Rybzynski theorem exet that the result deends on the setoral seiiity o the exanding ator rather than on ator intensities in rodution. B. Groth in the labor ore No let onsider hen e have a rise in the endoment o the mobile ator. Labor ill be divided beteen both setors and exands both oututs.

5 VMPL VMPL VMPL VMPL * Labor in Labor in Inrease in labor Thereore, e an summarize the eet o a hange in ator endoments as ollos: Fator endoments and oututs: An inrease in one seii ator inreases the outut o the ommodity that uses that ator and redues the outut o the other industry. An inrease in the suly o the mobile ator ill exand both oututs. We an see that hat determines the inrease/derease in outut is ator seiiity and ator mobility rather than the ator intensity o rodution. Outut ries: Let onsider no ho hanges in outut ries aets the ator ries and outut level. Let onsider hen the rie o ish inreases, The demand or labor in the ish industry shits u as VMPL inreases.

6 VMPL VMPL * Labor in Labor in One obvious eet is that hen rie o ish inreases, the outut o ish inreases hile the outut o his dereases. Next, onsider the real return. Consider the real return o labor, e an see that age rate inreases; thereore, labor enjoys higher real returns measured in terms o their ability to urhase his. For the oner o k, sine labor moves to the ish industry, MP k inreases so as the rental rie o K. Thereore the oners o K has high real return in terms o his rie. Finally, the E aital oners have loer real return in terms o rie o his, so as rie o ish. No e are let to make onlusions about the real returns o oners o r aital K and labor relative to rie o ish. First sine MPK P =. As MPK inreases, the oners o the aital K gain higher real return rom the rie hange. Finally, MPL P =, ith the inrease in labors in the ish industry and ixed amount o K, = MPL dereases. So labor has higher return in terms o the rie o his P but loer return relative to rie o ish. We an summarize the result in the olloing onlusion. Outut ries and ator ries A relative rie inrease o a good beneit the seii ator used in that industry, redues the real return o the other seii ator, and has an ambiguous eet on real return o the mobile ator (deending on their reerenes toard his and ish). Trading Equilibrium What determines omarative advantage? Reall: Country A has a omarative advantage in ish relative to Country B i the oortunity ost o ish in terms o his is loer in A than in B.

7 This means : A B ( ) < ( ) MPL A MPL ( ) < ( ) MPL MPL B The eet o ree trade or a small oen eonomy Small oen eonomy takes the orld ries as given and annot alter the orld ries. This ountry has omarative advantage in ish. So there are to adjustments: more suly and less demand.

8 From trade triangle, U T > U A so overall the ountry gains rom trade. But A T A T does everyone gains? A hange rom ( ) to ( ). Let assume that C = C and A inreases to Labor: = d = T MPL MPL d. What is the eet o an inrease in the rie o ish on inomes? At oint B, d d = or % % Δ = Δ. Hoever, > so % Δ > % Δ. Thereore, the real inome in terms o rie o his inreases hile the real return in terms o rie o ish dereases. The K-aital oners

9 L Wage inome in ish x =. What is y? It is F L = hih is a return to aital measured in ish. Beause F = L + rk rom eret ometition, no e kno that: 1. ( ) A > ( ) T ages rise less than the rodut rie rise 2. rk rk rk ( ) T > ( ) A I K aital oners an buy more ish, then they an surely buy more his. So aital oners are neessarily better o. The E-aital oners We kno that 1. ( ) A > ( ) T age inreases beause rie o his is onstant 2. re ( E ) T re < ( E ) A

10 I they an buy eer his, they must surely be able to buy even less ish than beore. So the E-aital oner loses rom trade. Summary: - E,K,L all determine omarative advantage. - More o a seii ator means you are likely to have a omarative advantage in the good using it. (Think o oil reserves). - Free trade hanges relative rie and this alter rodution atterns and inomes. - Seii ators gain i in the movement to ree trade, the relative rie o their rodut rises; they lose i it alls. - Whether the mobile ator labor gains or loses rom trade deends on their reerenes and onsumtion o the to goods. - Free trade auses onlit among grous o eole.