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info@economicshomeworkhelper.com Submit Assignment For Help Go To Answer Directly Problem Set 2 There are two countries, denoted by i = 1 , 2 . Each country produces a mass (continuum) of traded goods N and of non-traded goods P . Each good is produced by an individual monopolist. There is no overlap between the goods produced by one country and those produced by the other country. All consumers have a utility given by � N 0 � 1 /α c α k dk , where α ∈ (0 , 1) , and N = N + P + N + P is the total (maximum) number of goods. The goods are ordered as follows: • k ∈ [0 , P 1 ] = ⇒ Non traded good produced by country 1 • k ∈ [ P , N 1 + P 1 ] = ⇒ Traded good produced by country 1 • k ∈ [ N + P 1 , P 1 N 1 + P 1 + N 2 ] = ⇒ Traded good produced by country 2 • k ∈ [ N + + N 2 , N ] = ⇒ Traded good produced by country 2 The price charged by producer of good k is denoted by p . One will denote σ = 1 / (1 − α ) and µ = σ/ ( σ − 1) . 1. Compute the demand function for each of the four types of goods, as a function of its price, the aggregate nominal national income of each country Y , and other producers’ prices. Show that the contribution of other producers’ prices can be summarized using these two price indices=: � 1 � N 1 +P 1 +N 2 � 1−σ 1−σ dk p¯ 1 = p k 0 1 N � 1−σ 1−σ dk p¯ 2 = � � p k P 1 The production function for any good k is given by y = q l , where q is the quality of the manager hired by the ﬁrm (each ﬁrm uses exactly 1 manager), and l is its labor input. w is the wage of raw labor in country i. 2. Show that the price charged by a ﬁrm with managerial quality q in country i is w i p = µ q k . Compute the output and employment of a ﬁrm as a function of its managerial quality, wages, aggregate income and price indices, in the four cases. https://www.economicshomeworkhelper.com 1 1 " id="pdf-obj-0-2" src="pdf-obj-0-2.jpg">

Problem Set 2

info@economicshomeworkhelper.com Submit Assignment For Help Go To Answer Directly Problem Set 2 There are two countries, denoted by i = 1 , 2 . Each country produces a mass (continuum) of traded goods N and of non-traded goods P . Each good is produced by an individual monopolist. There is no overlap between the goods produced by one country and those produced by the other country. All consumers have a utility given by � N 0 � 1 /α c α k dk , where α ∈ (0 , 1) , and N = N + P + N + P is the total (maximum) number of goods. The goods are ordered as follows: • k ∈ [0 , P 1 ] = ⇒ Non traded good produced by country 1 • k ∈ [ P , N 1 + P 1 ] = ⇒ Traded good produced by country 1 • k ∈ [ N + P 1 , P 1 N 1 + P 1 + N 2 ] = ⇒ Traded good produced by country 2 • k ∈ [ N + + N 2 , N ] = ⇒ Traded good produced by country 2 The price charged by producer of good k is denoted by p . One will denote σ = 1 / (1 − α ) and µ = σ/ ( σ − 1) . 1. Compute the demand function for each of the four types of goods, as a function of its price, the aggregate nominal national income of each country Y , and other producers’ prices. Show that the contribution of other producers’ prices can be summarized using these two price indices=: � 1 � N 1 +P 1 +N 2 � 1−σ 1−σ dk p¯ 1 = p k 0 1 N � 1−σ 1−σ dk p¯ 2 = � � p k P 1 The production function for any good k is given by y = q l , where q is the quality of the manager hired by the ﬁrm (each ﬁrm uses exactly 1 manager), and l is its labor input. w is the wage of raw labor in country i. 2. Show that the price charged by a ﬁrm with managerial quality q in country i is w i p = µ q k . Compute the output and employment of a ﬁrm as a function of its managerial quality, wages, aggregate income and price indices, in the four cases. https://www.economicshomeworkhelper.com 1 1 " id="pdf-obj-0-14" src="pdf-obj-0-14.jpg">

There are two countries, denoted by i = 1, 2. Each country produces a mass (continuum) of traded goods N i and of non-traded goods P i . Each good is produced by an individual monopolist. There is no overlap between the goods produced by one country and those produced by the other country. All consumers have a utility given by

 � � N 0 � 1/α c α k dk , where α ∈ (0, 1), and N = N 1 + P 1 + N 2 + P 2 is the total (maximum) number of goods. The goods are ordered as follows: • k ∈ [0, P 1 ] =⇒ Non traded good produced by country 1 • k ∈ [P 1 , N 1 + P 1 ] =⇒ Traded good produced by country 1 • k ∈ [N 1 + P 1 , P 1 N 1 + P 1 + N 2 ] =⇒ Traded good produced by country 2 • k ∈ [N 1 + + N 2 , N ] =⇒ Traded good produced by country 2

The price charged by producer of good k is denoted by p k . One will denote

σ = 1/(1 α) and µ

= σ/(σ 1).

• 1. Compute the demand function for each of the four types of goods, as

a function of its price, the aggregate nominal national income of each country Y i , and other producers’ prices. Show that the contribution of other producers’ prices can be summarized using these two price indices=:

1
N 1 +P 1 +N 2
� 1−σ
1−σ dk
p¯ 1 =
p
k
0
1
N
� 1−σ
1−σ dk
p¯ 2 = � �
p
k
P 1

The production function for any good k is given by y k = q k l k ,

where q k is the quality of the manager hired by the ﬁrm (each ﬁrm uses exactly 1 manager), and l k is its labor input. w i is the wage of raw labor in country i.

• 2. Show that the price charged by a ﬁrm with managerial quality q k in

country i is

w i

p k = µ

q k

.

Compute the output and employment of a ﬁrm as a function of its managerial quality, wages, aggregate income and price indices, in the four cases.

1

1

• 3. Compute the proﬁt of a ﬁrm in the four cases, denoted as functions

π P 1 (q ), π N 1 (q ), π N 2 (q ), π P 2 (q ).

We now try to characterize the wage schedule ω i (q ), which tells us how much a manager of quality q earns in country i. Firms chose their managerial quality by maximizing π (q ) ω (q ), where π (.) is the relevant proﬁt function for the type of ﬁrm being considered.

• 4. Show that if two types q, q are both employed by exporting ﬁrms in

country i, then it must be that ω i (q ) ω i (q ) = π N i (q ) π N i (q ),

and that a similar equality holds if they are both employed by non-exporting ﬁrms.

We assume each individual is endowed with one unit of labor exactly, and q units of managerial quality. In country i, managerial quality is distributed over [0, q¯ i ], with c.d.f F i (q ), and density F i (q ) = f i (q ). Furthermore, total labor force in country i L i is such that L i > N i + P i . People have to fully specialize between being a manager or a worker.

• 5. Show that in equilibrium if a manager type q is employed in an exporting

ﬁrm then any manager with q > q is also hired by an exporting ﬁrm.

We thus look for an equilibrium such that in country i, there exists two critical values q P i , q N i such that q P i < q N i and -if q [0, q P i ] , the worker supplies labor -if q [q P i , q N i ] , the worker becomes a manager in the non-traded sector -if q [q N i , q¯ i ], the worker becomes a manager in the traded sector

• 6. What are the values of q P i and q N i ? What are the values of the price

indices p¯ i as a function of the wages w i , the critical levels q P i and q N i , and the

distributions of managerial quality?

• 7. So that the wage schedule for managers is given by

ω (q P i )

=

w i + π P 1 (q ) π P 1 (q P i ), q [q P i , q N i ]

w i + π P 1 (q N i ) π P 1 (q P i ) + π N 1 (q ) π N 1 (q N i )

How does the return to managerial quality evolve when one moves up the quality ladder, if σ > 2?

• 8. Show that Y i = µw i L i F (q P i ) and that the model can be closed either by

–Writing one of two (redundant) labor market clearing conditions and pick­

ing a price normalization

2

–Writing one of two (redundant) trade balance equilibrium conditions and

picking a price normalization.

We normalize prices so that w 1 = 1

9. Show that the highest wage in country 1 is

ω

q

1

)

=

1 + (µ 1)µ

σ

q

σ 1 q σ 1 ) Y 1 p¯ σ 1

1

N 1

1

+(µ 1)µ σ (q

1 q P 1

σ

N 1

σ 1 ) Y 1 p¯ σ 1 .

1

+

Y 2

p¯

σ 1

2

10. We now look at the eﬀect of increases in international trade in country

one, by assuming a marginal increase in N 1 , dN 1 > 0, compensated by a fall

in P 1 , dP 1 = dN 1 , so that the total number of goods in country 1 remains

constant. We measure inequality by the ration between the highest and the

lowest wage.

Show that, holding Y i and p¯ i constant, this shift increases inequality. Why?

11.

How would you go about evaluating the indirect contribution of the

induced changes in Y i and p¯ i in country 1?

3

Spring 2004

Problem Set 2 Solution

• 1. First let’s ignore that some goods are non-traded. The ﬁrst order condition of the consumer problem is

��

0

N

c

α

l

dl

• 1 1

α

c

α1

k

= λp k

where λ is the multiplier on the budget constraint. Solving for c k and substituting

into the budget constraint to solve for λ, we get the demand functions

c k =

p

σ

k

p¯ 1σ

Y

where Y is income and p¯ =

N

0

1

p 1σ dk 1σ is the consumption based price index.

l

Taking into account non-tradability, we get

c k =

⎪ ⎪ ⎨

⎩ ⎪

Y 1

¯ 1σ

p

1

p

σ

k

,

Y 1

p¯

1σ

1

+

Y 2

p¯

1σ

2

Y 2

¯ 1σ

p

2

p

σ

k

,

p

σ

k

,

k [0,

P 1

]

k

[P 1 ,

P 1

+

N 1

+

N 2

]

k

[P 1 + N 1 + N 2 , N ]

• 2. Proﬁts up to a constant are given by p

k

p k = µ w i . Then output is given by

q k

w i

q k

p

σ

k

, so proﬁt maximization implies

y k =

⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎨

⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎩

Y 1

p¯ 1σ

1

µ

w 1

q k

σ

,

Y 1

p¯

1σ

1

+

Y 2

p¯

1σ

2

� �

µ

1 σ

w

q k

Y 1

p¯

1σ

1

+

Y 2

p¯

1σ

2

� �

µ

w 2

q k

σ

Y 2

p¯

1σ

2

µ

2 σ

w

q

k

,

,

,

k [0,

P 1

]

k

[P 1 ,

P 1

+

N 1

]

k

[P 1 +

N 1

,

P 1

+

N 1

+

N 2

]

k [P 1 + N 1 + N 2 , N ]

and employment is

l k =

⎪ ⎪

⎪ ⎪

⎨ ⎪

⎪ ⎪ ⎪ ⎪ ⎪ ⎩

Y 1

(µw 1 ) σ

p¯ 1σ

1

1σ

q

k

+ p¯

Y 2

+

p¯

1σ

2

,

Y 1

(µw 1 )

1σ

q

k

σ ,

p¯ 1σ

1

Y 1

p¯

1σ

1

1σ

2

Y 2

,

(µw 2 ) σ

1σ

q

k

Y 2

p¯

1σ

2

(µw 2 ) σ

1σ

q

k

,

k [0, P 1 ]

k [P 1 , P 1 +

N 1 ]

k

[P 1 +

N 1

,

P 1

+

N 1

+

N 2

]

k [P 1 + N 1 + N 2 , N ]

1

• 3. Proﬁts functions are

� 1−σ
� w 1
π P
1 (q ) =
Y 1−σ 1 (µ − 1)µ −σ
q k
1
� 1−σ
Y 1
Y 2
� w 1
π
1 (q ) =
+
(µ − 1)µ −σ
N
p¯ 1−σ
1−σ
q k
1
2
� 1−σ
Y 1
Y 2
� w 2
π
2 (q ) =
+
(µ − 1)µ −σ
N
p¯ 1−σ
1−σ
q k
1
2
� 1−σ
� w 2
π P
2 (q ) =
Y 1−σ 2 (µ − 1)µ −σ
q k
2
4.
There is symmetry among exporting ﬁrms in country i. Thus diﬀerent types of
managerial quality used in equilibrium must give rise to the same proﬁts. The same
is true for non-exporting ﬁrms.
5.
Suppose to the contrary that a manager with q � > q is hired by a non-exporting ﬁrm.
Then we get
π P i (q � ) − ω i (q � ) ≥
π P i (q ) − ω i (q )
π N i (q ) − ω i (q ) ≥
π N i (q � ) − ω i (q � )
The ﬁrst inequality states that non-exporting ﬁrms do at least as well with a manager
of ability q � as with a manager of ability q . The second inequality states that the
reverse is true for exporting ﬁrms. Combining these inequalities yields
π P i (q � ) − π P i (q ) ≥ π N i (q � ) − π N i (q ).
This is a contradiction: since exporting ﬁrms have a larger market, an increase in
managerial ability is associated with a larger increase in proﬁts than for non-exporting
ﬁrms.
6.
Each exporting ﬁrm needs a manager, so the upper critical value q N i satisﬁes L i (1 −
F (q N i )) = N i , which implies
N i �
q N i = F −1
1 −
L
i
Each non-exporting ﬁrm also needs a manager, so the lower critical value q P i satisﬁes
L i (1 − F (q P i )) = N i + P i . Thus
N i + P i �
1 −
q P i = F −1
L
i

2

The price indices must satisfy

7.

� 1−σ
q¯ 1
1−σ
q N 1
w 1
w
p¯ 1−σ
1
= L 1
� µ
f 1 (q )dq + L − 1
µ
f 1 (q )dq
1
q
q
q
q
P 1
N 1
q¯ 2
1−σ
w
2
+ L 2
µ
f 2 (q )dq
q
q
N 2
� 1−σ
q N 2
w 2
1−σ
= L 2
� µ
f 2 (q )dq
2
q
q
P 2
q¯ 2
1−σ
q¯ 1
1−σ
w
w
2
1
+ L 2
µ
f 2 (q )dq + L 1
µ
f 1 (q )dq
q
q
q
q
N 2
N 1
To see how this result is obtained, consider the ﬁrst term of p¯ 1−σ , which corresponds
1
to the P 1 non-exporting ﬁrms in country 1. All managers in the range [q P 1 , q N 1 ]
will be assigned to this ﬁrms, and since ﬁrms are identical it does not matter which
manager is assigned to which ﬁrm, so we can think of assigning them randomly. The
� 1−σ
term is then the expected value of � µ
w 1
for these goods times the number of
q
goods:
� 1−σ
µ
w 1
f 1 (q )dq
q
q N 1
P 1
q
P 1
q N
1
f 1 (q )dq
q P 1
q N
1
Of course by construction �
f 1 (q )dq =
P 1
1 , so the term reduces to the one in the
L
q P 1
formula above. Another way of deriving this term is to think of managers not as
assigned randomly but instead in ascending order as a function of the index of the
good. Then the quality of the manger assigned to good k in country 1 is given by
k − (N 1 + P 1 ) �
−1
q 1 (k ) = F
1 +
1
L
1
and the term can be written as
1−σ
P 1
w
1
µ
dk.
q (k )
0
dq
1
1
Noting that
=
1 , a change of variables shows that this gives the same answer.
dk
f 1 (q ) L
It does not really matter how the schedule looks to the left of q P i , as long at it is
below w i .
Part 4 pins down the shape on the intervals [q P i , q N i ] and [q N i , q¯ i ].
We

only need to determine what happens at the critical values. Clearly it must be equal

to w i at q P i . If it is below w i the agent would rather be a worker, if it is above

w i , then ﬁrms in the non-exporting sector would rather hire a manager with ability

slightly less that q P i . The schedule must also be continuous at q N i .

If it jumps up,

3

exporting ﬁrms would rather hire a manager with ability slightly less than q N i . If

it jumps down, non-exporting ﬁrms would rather hire a manager with ability slighty

above q N i . Continuity in combination with the result from part 4. implies the wage

schedule for managers

ω (q ) =

w i +

π P

1 (q ) π P 1 (q P i )

w i + π P 1 (q N i ) π P 1 (q P i ) + π N 1 (q ) π N 1 (q N i )

q [q P i , q N i ]

q

[q

N i

, q¯ i

]

where for simplicity we set the schedule equal to w i to the left of q P i . Taking deriva­

tives

Y i
(µ − 1)µ −σ w 1−σ (σ − 1)q σ −2
q ∈ (q P i , q N i )
1−σ
i
ω � (q ) = ⎨
i
Y 1
Y 2
� (µ − 1)µ −σ w 1−σ (σ − 1)q σ −2
q ∈ (q N
i , q¯ i )
p¯ 1−σ
1−σ
i
+ p¯
1
2
Thus σ > 2 implies that the return to managerial quality is increasing as one moves
up the quality ladder, with an upward jump at q N i .
8. Total revenue from the production of good k is given by µw i l k , so summing across
goods yields the total income Y i = µw i L i F (q P i ) = µw i [L i − (N i + P i )]. The labor
market clearing conditions are
−σ
q ¯ 1
−σ
q N 1
Y 1
(µw
)
1
Y 1
Y 2
� (µw
)
1
L
f 1 (q )dq
+
L
+
f 1 (q )dq
=
L 1 − (N 1 + P 1 )
1
1
1−σ
p¯ 1−σ
1−σ
q
1−σ
1−σ
q
q
1
q
1
2
P 1
q N 2
N 1
−σ
q ¯ 2
−σ
Y 2
(µw
)
2
Y 2
Y 1
� (µw
)
2
L
f 2 (q )dq
+ L 2
f 2 (q )dq = L 2 − (N 2 +
P 2 )
2
1−σ
q
1−σ
1−σ +
1−σ
q
1−σ
q
2
q
2
1
P 2
N 2
To see that one of the two is redundant, multiply the ﬁrst by µw 1 and the second by
µw 2 :
� µw 1 � 1−σ
q N 1 Y 1
q ¯ 1
� 1−σ
Y 1
Y 2
� � µw 1
L
f 1 (q )dq
+ L 1
+
f 1 (q )dq
= Y 1
1
1−σ
p¯ 1−σ
1−σ
q
q
q
1
q
1
2
P 1
N 1
� µw 2 � 1−σ
q N 2 Y 2
q ¯ 2
� 1−σ
Y 2
Y 1
� � µw 2
L
f 2 (q )dq
+ L 2
f 2 (q )dq = Y 2
2
2−σ
1−σ +
1−σ
q
q
q
2
q
2
1
P 2
N 2
Now add them up and collect terms:
N 1 � µw 1 � 1−σ
� µw 1 � 1−σ
� µw 2 � 1−σ
q
q ¯ 1
q ¯ 2
Y 1
L
f 1 (q )dq + L 1
f 1 (q )dq +
L 2
f 2 (q )dq
1
1−σ
q
q
q
1
q
q
q
P 1
N 1
N 2
N 2 � µw 2 � 1−σ
� µw 2 � 1−σ
� µw 1 � 1−σ
q
q ¯ 2
q ¯ 1
Y 2
+
L
f 2 (q )dq + L 2
f 2 (q )dq +
L 1
f 1 (q )dq
2
1−σ
q
q
q
2
q
q
q
P 2
N 2
N 1
= Y 1 + Y 2

4

Using the formulas for the price indices, this reduces to the identity Y 1 + Y 2 = Y 1 + Y 2 .

� µw 2 � 1−σ
� µw 1 � 1−σ
q¯ 2
q¯ 1
Y 1
Y 2
f 2 (q )dq =
f 1 (q )dq
1−σ L 2
1−σ L 1
q
q
1
q
2
q
N 2
N 1
To see that it is redundant as well, combine it with the labor market clearing condition
of country 1 (the version multiplied by µw 1 ) to obtain
N 1 � µw 1 � 1−σ
� µw 1 � 1−σ
� µw 2 � 1−σ
q
q¯ 1
q¯ 2
Y 1
L
f 1 (q )dq + L 1
f 1 (q )dq + L 2
1
1−σ
q
q
q
1
q
q
q
P 1
N 1
N 2
= Y 1
Using the formula for p¯ 1 , this reduces to the identity Y 1 = Y 1 . Using the normalization
w 1 = 1, any one of these three conditions can be used to determine w 2 .
9. Of course the best manger q¯ 1 is the one that receives the highest wage, and using the
normalization w 1 = 1:
ω (¯
q
1 ) = 1 + π P 1 (q N 1 ) − π P 1 (q P 1 ) + π N 1 (¯ ) − π
q
(q
)
1
N 1
N 1
Y 1
Y 1
Y 2
σ −1
σ
−1 � +
σ −1 �
= 1 +
(µ − 1)µ −σ � q N 1
− q
+
� (µ − 1)µ −σ � q¯ σ −1 − q
p¯ 1−σ
P 1
1−σ
1−σ
1
N 1
1
1
2
� 1−σ
Y 1
� w
1
π P
1 (q ) =
1−σ (µ − 1)µ −σ
q k
1
� 1−σ
Y 1
Y 2
� w
1
π
1 (q ) =
+
(µ − 1)µ −σ
N
p¯ 1−σ
1−σ
q k
1
2
� 1−σ
Y 1
Y 2
� w
2
π
2 (q ) =
+
(µ − 1)µ −σ
N
p¯ 1−σ
1−σ
q k
1
2
� 1−σ
Y 2
� w
2
π P
2 (q ) =
1−σ (µ − 1)µ −σ
q k
2

f 2 (q )dq

• 10. As N 1 + P 1 remains unchanged, there is no change in q¯ P 1 . Thus the only eﬀect comes through a decrease in q N 1 . As the highest wage depends negatively on q N 1 , this leads to an increase in inequality. What happens is that the returns to managerial quality increase over the range [q N 1 , q N 1 +dN 1 ].

• 11. You could go through a nightmare of algebra if you wanted to.

5