Chapter Three.pptx; Specific factors and income distribution
- 1. Chapter 3 : Specific Factors and Income Distribution
- 2. If trade is so good for the economy, why is there such opposition? As we saw in Chapter 2, international trade can be mutually beneficial to the nations engaged in it. Yet throughout history, governments have protected sectors of the economy from import competition. For example, despite its commitment in principle to free trade, the United States limits imports of textiles, sugar, and other commodities.
- 3. If trade is so good for the economy, why is there such opposition? If trade is so good for the economy, why is there such opposition? To understand the politics of trade, it is necessary to look at the effects of trade, not just on a country but on the distribution of income within that country. In Ricardian model trade leads to international specialization, with each country shifting its labor force from industries in which that labor is relatively inefficient to industries in which it is relatively more efficient. Labor is assumed to be able to move freely from one industry to another, therefore, there is no possibility that individuals will be hurt by trade.
- 4. Cont… Two main reasons why international trade has strong effects on the distribution of income within a country: Resources cannot move immediately or costless from one industry to another. Industries differ in the factors of production they demand. The Specific Factors Model: This was developed by Paul Samuelson and Ronald Jones. Like the simple Ricardian model, it assumes an economy that produces two goods and that can allocate its labor supply between the two sectors.
- 5. The Specific Factors Model The specific factors model allows trade to affect income distribution. Assumptions of the model: Two goods, cloth and food. Three factors of production: labor (L), capital (K) and land (T for terrain). Perfect competition prevails in all markets Cloth produced using capital and labor (but not land). Food produced using land and labor (but not capital). Labor is a mobile factor that can move between sectors. Land and capital are both specific factors used only in the production of one good
- 6. The Production Possibility Frontier in the Specific Factors Model
- 7. Why is the production possibilities frontier curved? Why is the production possibilities frontier curved? Diminishing returns to labor in each sector cause the opportunity cost to rise when an economy produces more of a good. Opportunity cost of cloth in terms of food is the slope of the production possibilities frontier – the slope becomes steeper as an economy produces more cloth.
- 8. How much labor is employed in each sector? The Economy need to look at supply and demand in the labor market. Demand for labor: In each sector, employers will maximize profits by demanding labor up to the point where the value produced by an additional hour equals the marginal cost of employing a worker for that hour.
- 9. The Allocation of Labor
- 10. International Trade in the Specific Factors Model Trade and Relative Prices The relative price of cloth prior to trade is determined by the intersection of the economy’s relative supply of cloth and its relative demand. Free trade relative price of cloth is determined by the intersection of world relative supply of cloth and world relative demand. Opening up to trade increases the relative price of cloth in an economy whose relative supply of cloth is larger than for the world as a whole.
- 11. International Trade in the Specific Factors Model (cont.) Gains from Trade Without trade, the economy’s output of a good must equal its consumption. International trade allows the mix of cloth and food consumed to differ from the mix produced. The country cannot spend more than it earns: PC x DC + PF x DF = PC x QC +PF x QF
- 12. International Trade in the Specific Factors Model (cont.) The economy as a whole gains from trade. It imports an amount of food equal to the relative price of cloth times the amount of cloth exported: DF - QF = (PC / PF) x (QC – DC ) It is able to afford amounts of cloth and food that the country is not able to produce itself. The budget constraint with trade lies above the production possibilities frontier in Figure 4-11.
- 13. The Budget Constraint for a Trading Economy and Gains from Trade
- 14. Income Distribution and the Gains from Trade International trade shifts the relative price of cloth to food, so factor prices change. Trade benefits the factor that is specific to the export sector of each country but hurts the factor that is specific to the import-competing sectors. Trade benefits a country by expanding choices. Possible to redistribute income so that everyone gains from trade. Those who gain from trade could compensate those who lose and still be better off themselves. That everyone could gain from trade does not mean that they actually do – redistribution usually hard to implement
- 15. The Political Economy of Trade: A preliminary view Trade often produces losers as well as winners. Optimal trade policy must weigh one group’s gain against another’s loss. Some groups may need special treatment because they are already relatively poor (e.g., shoe and garment workers in the United States). Most economists strongly favor free trade.
- 16. Trade and Unemployment Trade shifts jobs from import-competing to export sector. Process not instantaneous – some workers will be unemployed as they look for new jobs. How much unemployment can be traced back to trade? From 1996 to 2008, only about 2.5% of involuntary displacements stemmed from import competition or plants moved overseas. Unemployment is primarily a macroeconomic problem that rises during recessions. The best way to reduce unemployment is by adopting macroeconomic policies to help the economy recover, not by adopting trade protection.
- 17. Unemployment and Import Penetration in the U.S.
- 18. Movements in Factors of Production Movements in factors of production include Labor migration The transfer of financial assets through international borrowing and lending Transactions of multinational corporations involving direct ownership of foreign firms Like movements of goods and services (trade), movements of factors of production are politically sensitive and are often restricted.
- 19. International Labor Mobility Why does labor migrate and what effects does labor migration cause? Workers migrate to wherever wages are highest. Consider movement of labor across countries instead of across sectors. Suppose two countries produce one non-traded good (food) using two factors of production: Land cannot move across countries, but labor can.
- 20. Causes and Effects of International Labor Mobility
- 21. Summary 1. International trade often has strong effects on the distribution of income within countries -- produces losers as well as winners. 2. Income distribution effects arise for two reasons: Factors of production cannot move costlessly and quickly from one industry to another. Changes in an economy’s output mix have differential effects on the demand for different factors of production. 3. International trade affects the distribution of income in the specific factors model. Factors specific to export sectors in each country gain from trade, while factors specific to import-competing sectors lose. Mobile factors that can work in either sector may either gain or lose.
- 22. Summary (cont.) 4. Trade nonetheless produces overall gains in the sense that those who gain could in principle compensate those who lose while still remaining better off than before. 5. Most economists would prefer to address the problem of income distribution directly, rather than by restricting trade. 6. Those hurt by trade are often better organized than those who gain, causing trade restrictions to be adopted. 7. Labor migrates to countries with higher labor productivity and higher real wages, where labor is scarce. Real wages fall due to immigration and rise due to emigration. World output increases. 8. Real wages across countries are far from equal due to differences in technology and due to immigration barriers.