Distortions in Factor Markets and The General Equilibrium Model of Production Ronald W. Jones

in FactorMarketsand the
Distortions
GeneralEquilibriumModel
of Production
RonaldW.Jones
Universityof Rochester
A premiumpaid to a factorof productionin one industryover the

returnearned by the same factorin the otherindustryin a two-sector
model is a distortionthat affectsall factorpricesand the general ef-
ficiencyof production.It allows forthe possibilitythat the industry
employingthe higher capital-labor ratio nonetheless pays labor a
higherdistributiveshare. In such a case, commodityoutputs are in-
verselyrelatedto commodityprices.Furthermore,the paper explores
scheduleand
how distortionscan affectthe shape of the transformation
the optimalstrategyto be followedby a factorof productionintenton
maximizingits returns.
The standard Heckscher-Ohlin model of international trade comprises

only one of several applications of a competitive two-sector, two-factor
model of general equilibrium. If factor intensities differbetween sectors
and technology exhibits constant returns to scale, the production-pos-
sibilities schedule is bowed out from the origin and, in the region of in-
complete specialization, an increase in a commodity's relative price re-
sults in an increase in the quantity of that commodity produced. These
features of the model are used extensively in trade theory, in two-sector
neoclassical growth models, and in general equilibrium treatments of
issues in public finance.
Distortions in the factor market that take the form of a greater re-
ward being paid to a factor in one industry than to the qualitatively
identical factor in the other industry lead generally to a loss of economic
efficiencyresulting in the community's output lying below the non-
distorted transformation curve. If the distortion is sufficientlysevere,
I am indebted to Richard Caves, Harry Johnson, and Al Klevorick for useful
discussions of this material. I have benefitedfromcomments given at presentations
of this paper to the Joint Oxford-London School of Economics Trade Seminar, the
Universityof Essex, and the Universityof Pennsylvania. I also wish to thank Stephen
Magee forlong conversations stimulated by his paper.
437
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438 JOURNAL OF POLITICAL ECONOMY
the transformation schedule may in certain sections become bowed in

toward the origin.Furthermore,the commodityprice ratio cannot in
this case be identifiedwith the slope of the (distorted)transformation
curve,and it is no longerthe case that an increasein the productionof
a commoditymust, for given distortionlevels, be associated with an
increasein the relativepriceof that commodity.
These issues have lately claimed the attentionof a numberof econo-
mists. In an early contribution,Harberger (1962) provided a general
equilibriumanalysis of a particular kind of distortionto the factor
capital, the corporationincome tax. The same frameworkhas been
utilized by Johnsonand Mieszkowski (1970) to analyze the impact of
unionizationon the rewardsto organizedlabor.' The inherentlymore
difficultquestions concerningthe consequences of distortionsfor the
shape of the production-possibilities locus were explored by Johnson
(1966) and, more recentlyand in more detail, by Herbergand Kemp
(1971) and Bhagwati and Srinivasan(1971). Perhaps a moreinteresting
featureof the distortionsproblemis the possibilitythat outputsrespond
inverselyto movementsin relativecommoditypricesand that this be-
havior does not necessarilycorrespondto those regionsin which the
transformation scheduleis (locally) bowed in towardthe origin.2
In thispaper I intendto surveythisrangeof issues by relyingheavily
on the particularapproach to simplegeneralequilibriummodelsof pro-
ductionthat I developed some years ago (Jones 1965). The basic model
is laid out in SectionI. In SectionII, I concentrateon the impactof dis-
tortionchanges on the distributionof factorincome. The rathercom-
plicated questionsconcerningthe shape of the distortedtransformation
scheduleare discussedin SectionIJJ,primarilyforthe constantelasticity
of substitution(CES) case, which is the only case so far investigated
that yieldssomewhatdefiniteresults.I relegateto the Appendixone of
the more technical proofsinvolved in this section. In the concluding
section,I returnto the question of factorrewardsto argue that, if the
purposeof the analysisis to investigatethe optimumstrategyfora par-
ticular factorof production(union labor), it may be more instructive
to focuson distortionsthat take the formof restrictionson factormo-
bilityinsteadof prescribeddifferentials in factorrewards.
I
The basic equilibriumrelationshipsin this two-commodity,two-factor
model of generalequilibriumare provided by the pair of full-employ-
1 In his unpublished paper, "Factor Market Distortions and the Pure
Theory of
International Trade," Magee also considers this aspect of the problem.
2 This aspect of the problem is discussed in Herberg and Kemp (1971), Magee (see
n. 1 above), and Bhagwati and Srinivasan (1971).

DISTORTIONS IN FACTOR MARKETS 439
mentrelations,(1) and (2), and the competitivezero-profit

relationships,
(3), and (4):
aL1Xl + aL2X2 = L, (1)
aK1Xl + aK2X2 = K, (2)
aL1W1 + aKir = piX (3)

aL2w2 + aK2r = P2. (4)
Distortionsare assumed to appear only in the labor marketand to take

the formof a differential separatingthe wage rates,wi, in the two in-
dustries.To retainsymmetryin the expressions,I introducetwo distor-
tion parameters,ai, so that wi equals a-w. The quantity w is purely
fictitious,and in what followsthereis no loss in settinga2 identicalto
unity so that the distortionis a premiumearned by labor in the first
industryifa,/a2 (or a,) exceedsunity.3The otherterminology is straight-
forward:The aij referto input-outputcoefficients for factori (either
labor,L, or capital,K) in industryj(whoseoutputis Xj). The commodity
price in sector j is given by pj.
of (1)-(4),
The equations of change, derived by total differentiation
are shownin equations (5)-(8). Relative changes in a variable are de-
notedby the circumflex(^) notation,so that,forexample,X2 is dX2/X2:
XLlXl + XL2X2 = L - [XLldLi + XL2aL2], (5)
XKlXl + XK2X2 = K - [XK1aK1 + XK2aK21, (6)

OL1W1 + OKlr = p- [OLlaLl + OKjaK1] , (7)
OL2W2 + OK2r = P2 - [6L26L2 + GK26K2] . (8)

Two sets of coefficientsappear in these relationships,the [X]matrixof
factorallocationfractionsand the [0] matrixof distributiveshares. For
example,XLi is aLLXI/L, the fractionof the labor forceused in the first
industry,and OK2 is raK2/p2, capital's distributiveshare in the second
industry.
Clearly, the next step involves expressingthe change in the input-
outputcoefficients,ai, in termsof factorpricechangesand any possible
distortionchanges,and then solvingforoutput changesand changesin
factorprices.Beforeproceedingwiththe analysis,however,it is crucial
to note the role that will emergefor the determinantsof coefficients,
1X and 0 1. The hallmark of the standard (undistorted) two-sector
model is that i X I and i 0 | must have identical signs, the value of which
is an indicationof the rankingof industriesby factorintensities.This
In an earlier version of this paper, I let the distortionparameters appear in the
capital market instead of the labor market. Then the term r, as opposed to ri, could
be used to refer,say, to the rental on capital in world markets, which might differ
fromthe rental in either sector at home.

need no longerbe the case if distortions(in the labor market) are suf-
severe.
ficiently
Simple calculationreveals that IXI is given by:
X1X2 i aLl aL2
LK
-aKlaK2_
aK1 aK2
Therefore,IXI is positiveif and only if the physicallabor-capitalratio

employedin the firstindustryexceeds that in the second. This is the
same kind of relationshipprevailingin the standardundistortedmodel.
However, a warningis in order, for the existenceof distortionsmay
cause the firstindustryto use physicallymorelabor-intensivetechniques
than the secondindustryeven if,in the undistortedcase, it would be the
capital-intensiveindustry.4
Similarly,I01 can be expanded as:
wr i aLl aL2
a~aK2 al -a
P1P2 K aK1 aK2
Suppose the firstindustryis, in a physical sense, the capital-intensive

industry.Then IXI is negative,but iflabor in the firstindustryis paid a
sufficientpremium(over nonunionizedlabor), I01 is positive.5This sug-
gests an alternativeview of factorintensityrankings:X1 is labor-in-
tensivein a value sense if the ratio of labor's to capital's distributive
sharesin the firstindustryexceedsthat in the second.This can be stated
more simplyby taking advantage of the fact that distributiveshares
in each industryadd to unityto note that an alternativeformfor I01
is givenby (OL1 - OL2).6 Thus, even if the second industryis physically
labor-intensive,a high premiumpaid to labor in the firstindustrycan
resultin a higherdistributiveshare forlabor in the (physically)capital-
intensivesector.
This distinctionis important.From equations (1) and (2), it is clear
that the rankingof industriesby physical factorproportions,as given
by the sign of IX 1, controlsthe relationshipamong the physical vari-
ables of the model: the commodityoutputsand the factorendowments.
From (3) and (4) it is equally clear that the relationshipsamong finan-
cial variables,factorrewardsand commodityprices,are goingto be af-
fectedlargelyby the rankingof industriesby distributiveshares, as
givenby thesignof I0 . If theserankingsdiffer, thelinkbetweenphysical
variables (for example, commodityoutputs) and financialvariables
I This would require a premium paid to labor in the second industry. Johnson
(1966) shows by means of box diagrams that a sufficientdistortionin factor markets
can always reversethe physical factorproportionranking fromthat prevailing in the
undistortedcase. This is illustratedbelow in fig.4.
5 Clearly, this requiresa distortionsuch that al/a2 exceeds the ratio of the physical
labor-capital ratio in the second industryto that in the first.
6
Similarly,IX I can be writtenas XL1 - XK1.

(for example, commodityprices) may be the opposite of that usually

encounteredin thesemodels.
All this is runninga bit ahead of the analysis,as it is necessary,first,
to solve forthe changesin input-outputcoefficients, a'i. Each industry
can be treated separately, so consider industry 1. The equilibrium
minimum-unit-cost relationshipis diagrammaticallyshown by the tan-
gencybetweena cost line (whose slope is the ratio of factorprices) and
the unit isoquant. Algebraically,this implies:
OLlaL1 + OKlaK1 = .
That is, in the absence of technical progress,the distributive-share

weightedaverage of changes in input-outputcoefficientsiszero. This
relationshipservesimmediatelyto simplifythe competitiveprofitequa-
tionsof change shownby (7) and (8).
Anotherlinkbetweena5l and aK1 is providedby the definitionof the
elasticityof substitution,v1, in the firstindustry.With the slope of the
isoquant representedby the negative wage-rentalratio in industry1,
v1is implicitlydefinedbelow:
aLla~~l-aLKl 1 = - _ r A1( _ ) v&
aK al (W1 -V A) 17) - - 016ja.
It is a simple matter to combine these two relationshipsto solve

separatelyforaLl and aKl:
aLl = -OK1fl(W1OK10- - 1a
aKl = OLlal(w - r) + OL101al6
These, and the similarcoefficientchanges for industry2, can then be

substitutedinto (5) and (6). Finally, let ?hiand fV2in (7) and (8) be
given by al + twand a2 + tw,respectively.With all these substitutions,
(5)-(8) reduceto (5')-(8'):
XLlXl + XL2X2= L + 6L (W - A) + [XLlOK10a-1+ XL2OK202a2], (5')
XKlXl + XK2X2 = A - aKA(W - )- [XKlOL10a'1 + XK2OL2T2a2] , (6')
where
6L - XLlOK10l1 + XL2OK2072 > 0, aK XKlOLLLT1 + XK2OL2072 > 0,
and
OL1W + OKlr = IN - OLlal, (7')
OL2W + OK2r = P2 - OL2 2* (8')
The firstset of relationshipsI wish to discuss involvesthe mannerin

which both the existenceof distortionsand the changes in distortions
affectthe linkbetweenfactorpricesand commodityprices.Subtracting
(8') from(7') immediatelyyieldsthe followingrelationship:
| ((w - =r (pl P2) + (OL252 - OLll)

This solutionfor(i1 - r) will be used in derivingexpressionsforoutput

changesfrom(5') and (6'). On its own,however,it is of less interestthan
the expressionsforchanges in the factorprice ratios in each industry,
(tbi- r), whichare readilyobtained by substitution:
(-z =-dA ( Pi P2) +

,ol (&2 -l)a
O -b ) =- (ol -A2) +
0 (&2- 1))
Two featuresof this solutionneed to be stressed.First, suppose com-

modityprices change in an economyin which distortionlevels remain
constant.As usual, an increase in pI/p2 has a magnifiedeffect( 01 a
fraction)on relativefactorprices.But the directionof the changein fac-
tor pricesdependson the sign of 01, which,as has been seen,may run
counterto the rankinggiven by physicalfactorproportions.Thus, even
if the firstindustryis capital-intensive(j XI < 0), the premiumpaid to
labor in the firstindustrymay be sufficiently greatto lead to a situation
in whichan increasein the relativepriceof the physicallylabor-intensive
commodity(p2/Pl) servesto lowerthewage raterelativeto the returnto
capital in thetwoindustries.Anysemblanceof paradoxdissolveswhenit
is pointedout that I0 ] positivemeansthat the secondindustryis capital-
intensivein a "value" sense.
Second, considerthe impact of changes in distortionsat fixedcom-
modityprices.As the expressionsabove suggest,an increasedpremium
paid to labor in the industryin which labor receives the smallerdis-
tributiveshare must raise the wage rate (relativeto the returnto capi-
tal) in bothindustries.From (7') and (8') it is clear that an increasein
ai at constantpricesworkslike a reductionin pi in affectingfactorprices.
Again,thesignof I 0 1is crucial.The previousremarkscan be put another
way. Suppose a factorof productionobtains a distortionin its favorin
the industryin whichit is used intensively(in the "value" sense of the
ranking).Then its return,relativeto that of the otherfactor,must fall
in both industries.That is, labor unionsmay be followinga shortsighted
policy if theypush fordiscriminatory higherwages in an industrythat
is (in "value" terms)labor-intensive.It remainsto be seen in the next
sectionwhetherthis result persistsonce commodityprices are allowed
to changeto clear marketswhen distortionlevels are altered.
These remarksinvolvea comparisonof the changedfateof one factor
relativeto that of the other. The magnificationeffect,wherebyfactor
prices change by a greater relative amount than commodityprices,
ensuresthat the "real" rewardsto factorsare affectedin the same direc-
tion. As an example,the changes in the "real" returnsto labor in the

firstindustryare exhibitedbelow. These are obtained by solving (7')

and (8') for , and noting that ,& = di + Th:
0| O ( 2) (9)
0K2 O
01a-2).(0
A
W P2ThTP1P2) Al _
Output changescan be derivedby subtracting(6') from(5'):

Ix (X1 X2) - = (L - K) + (aL + 3K) (W -r
+ {[XLiKi + XKiOLh07al + [XL2OK2 + XK20L2kf2a&2}-
This expressionconfirmsthe traditionalresultsin trade theorythat at

constant distortionlevels and factor prices (implyingconstant com-
modityprices) an increase in the labor-capitalendowmentratio must
increasethe relativeoutput of the commoditythat is physicallylabor-
intensive.Furthermore,it is clear that, if endowmentsand the factor
price ratio wir are both held constant,an increasedpremiumpaid to
labor in eitherindustryinvolvesa substitutionaway fromlabor in that
industryand affectsoutputs in the same way as would an increased
endowmentof labor and reduced endowmentof capital. Of more in-
terestthan this expression,however,is the relationshipbetweenoutput
changesand commodityprice changes,on the one hand, and distortion
changeson the other.This is obtained by substitutingthe linkbetween
(w - f) and price and distortionchanges previouslyexhibitedand is
shownin (I1):
I - - L + 6K
(X1 - X2) = T (L-K) + - __Al__
p2) 2)
where (11)
B = [XLl0Kl + XKl0L1]0L20f1 + [XL2OK2 + XK2OL2]0L10o2 and B > 0.
The conclusionsto be derived from(11) are straightforward. First,
note again that at constantcommoditypricesand distortions,the link
betweenendowmentchangesand outputchangesdependsas in standard
theoryonly upon the physical rankingof factorproportions.Second,
note that the effecteitherof price changes or of distortionchanges at
constantendowmentsdepends cruciallyon the sign of XI 01. In tradi-
tional theory,an increasein a commodity'srelativepricemust increase
the relativeoutput of that commodity.However,if the industrythat is
capital-intensive in termsof physicalproportionsnonethelesspays labor
a highershare of its proceeds than does the otherindustry,thistradi-
tional price-outputpattern is reversed.The reasoningis clear: an in-
crease in the relativepriceof the commoditythat is labor-intensivein a
value sense must raise the wage-rentratio. This serves to encourage

bothindustriesto economizeon laborand to use capital moreintensively.

For fullemploymentto be maintained,it is necessaryforthe industry
employinglabor relativelyintensivelyin a physicalsense to expand (to
soak up the released labor) and the other industryto contract.But if
IXI and I01 have opposite signs,the industrythat contractsis the in-
dustry in which price has risen. Long-runsupply curves in such an
economyare negativelysloped.
A change in distortionlevels at constantcommoditypricesworksin
the same way. On the one hand, an increase in the premiumpaid to
labor in the firstindustry,which acts like a loweringof industryl's
relativeprice,raises the returnto labor in both industriesonly if labor
receivesa smallershare in 1 than in 2 (I 01 negative). If so, a substitu-
tion away fromlabor proceedsin both industries,acting like a greater
relativeendowmentof labor and servingto increasethe output of the
commoditythat is labor-intensivein a physical sense. If this is in-
dustry1 (I XI > 0), a "perverse"outcomeresultsin which,at constant
prices,a greaterpremiumpaid to a factorin the firstindustryencourages
productionin that industry.
To summarize:Only if the factorintensityrankingin a value sense
correspondsto the rankingin a physicalsense ( A 1 > 0) will (i) an
increasein the relativepriceof a commodityincreaseits relativeoutput
and (ii) an increasein the premiumpaid to labor in an industryreduce
that industry'srelativeoutput at constantprices.
II
In this sectionI concentrateon the incomeredistribution effectsof an
increasein the premiumpaid to labor in one industryover that paid
in the other.Let the "unionized" sectorbe industry1. In the preceding
section,it was shown that if commodityprices are held constant,an
increasein a, mustraise the unionwage and depressthe returnto capital
if the unionizedsectoris capital-intensivein a "value" sense. If, on the
contrary,labor earns a higherdistributiveshare in the unionizedsector,
even if in physical termsit is capital-intensive,an increase in its pre-
miumearned over nonunionizedlabor must, at constantprices,reduce
union wages, raise rentals, and, as well, reduce nonunion wages. It
remainsto be shown whetherthis gain or loss in union wages is dis-
sipated, or perhaps reversed,by the subsequent change in commodity
pricesas marketsare cleared. I focusprincipallyon distinguishing those
cases in whichit would pay a labor unionto demand a higherpremium.'
Clearly,the linesof analysiswilldepend in part on whetherthe physi-
7 The criterionfor gain to the union is the change in the union real wage, w1/p1
and/or W1/P2-

cal rankingof factor intensitiescorrespondswith the value ranking.

Suppose it does, so that 1X1 01 > 0. Then supply response to price
changesis normalin the sense that an increasein PI/P2 would serve to
raise Xl/X2. This is incorporatedin the supply curve forrelativeout-
puts,S, shownin figure1. The most simple assumptionis made about
demand: as PI/P2 rises,the demand forX1 relativeto X2 falls.8An in-
crease in al/a2 shiftsthe supply curve leftward(it acts like a reduction
in PI/P2 in its effecton output,as shownby eq. [11]). The net impacton
unionwages is a compositeof two forcesworkingin oppositedirections:
(i) If pricesare kept at theiroriginallevel, Oa, union wages are raised
ifand only ifunionizedsector1 is capital-intensive.(Recall the assump-
tionmade initiallythat value and physicalrankingsof factorintensities
coincide.) (ii) As PI/P2 risesto Ob,unionwages are depressedifand only
if unionizedsector1 is capital-intensive.These two opposingtendencies
are explictlyshown in equations (9) and (10). Obviously,what is re-
quired is an expressionlinkingthe inducedrise in pI/p2 to the increased
distortionpremium,al/a2.
An explicitexpressionfor the extent of the change in the ratio of
X1/X2demandedcan be shownby the definition of the elasticityof sub-
stitutionin demand, CD, providedby equation (12) :9
(X1 - X2) = -OJD(p1 - P2) * (12)
P2 SD s s
/
a~~~~~~~
\b/ /
// /
0 XI
X2
FIG.1
8"This is equivalent to an underlying assumption that indifferencecurves are

homothetic. I ignore the complications introduced by allowing each factor group its
own differenttaste pattern.
9The termCD is defined so as to be positivefornegativelyslopeddemandcurves.

Set thisequal to the expressionforsupplychangesshownin (11), assum-

ing fixedfactorendowments,to obtain (13) as the expressionfor the
inducedchange in prices:
(p- P2) =-(&B -2)
wherea 6-L + SK + 1X 0 10D. The a is what has been defined(Jones

1965) as the overall elasticityof factorsubstitution-the reciprocalof
the percentagereductionin the wage-rentratio that would accompany
a 1 percentincreasein the labor-capitalendowmentratio. By directly
substitutingforthe 3L + bK expression(shown in eqq. [6'] and [7']), it
is clear that a is the followingpositivelyweightedaverage of all the
elasticitiesof substitutionin the system: between factorsin the two
industries(al and 0a2) and between commoditiesin consumption(o-D):
a = Qia0- + Q2a-2 + QD0-D
where
Q1 XLlKl + XK1OL1,
Q2 XL26K2 + XK2OL2,
QD -X| 101,
and 2QQi1.
But B, definedin (11), is also expressiblein termsof the positivefrac-
tionsQ, and Q2, so that the inducedpricechange can be given the alter-
native form(13'):
)
+ - (
Al_
A L2Q1a-l OLlQ2a-2
Q10a1 + Q2a-2 + QDa-D
From this,it is easy to see that as longas the demandcurveis negatively

sloped,theinducedrisein pl/p2 mustbe a fractionoftheinitialdistortion
change.'0This suggestsa lowerweightto be attached to the secondary
inducedpricechange than to the initialdistortionchange. But as equa-
tions(9) and (10) reveal,a givenrelativepricechangeis moreimportant
in affectingreal unionwages than would be the same relativedistortion
change." Thus, no clearresolutionemergesas to whichofthe two oppos-
ing forcesis moredominant.As will be shown,thisdependscruciallyon
how responsiveconsumersare to an alterationin prices.
Substitutethelinkbetweenthe pricechangeand the distortionchange
10 Consider the maximum possible rise in PO/P2 in the case in which the demand
curve is vertical (zero aD). Then the comparison involves the impact of a price rise
on outputs versus the impact of a distortion change. But a distortion change acts
in the same fashion as a price change, except watered down because only one factor
in unit costs is affected.Therefore,it takes a smaller price change than distortion
change to effectthe same output response.
11The reason is similar to that given in the previous footnote. Because labor
representsonly a fraction of unit costs, a distortion change has a smaller relative
impact on factorprices than has a commodityprice change.

shownby (13') into equations (9) and (10) forthe change in union real
wages to obtain (14) and (15):
OKi
( -1 i5) = {Q202 -
OL21 X I D}(1(a2) (14)
(-1 P2) = - {OL2Q1O_1+ Q20o2 - OK1OL21X |0D} (I1 a2) (15)
From these expressions,it is clear what union strategyshould be. If

the unionized sector 1 is capital-intensive(I X < 0), unions clearly
stand to gain ifpricesare kept fixed.These gains are whittleddown the
lowerthe demandelasticity,aD. But even in the extremecase of a verti-
cal relativedemand curve, the union wage rises relativeto eithercom-
modityprice. In the conversesituation,wherethe union sectoris labor-
intensive,the union clearly loses if demand is highlyelastic; this was
previouslydemonstratedfor the fixed-pricecase. However, union real
wages are helped to the extentthat the relativeprice rise in its sector
is sufficientlygreat. A low enoughvalue for aTD ensuresthat the union
real wage actually risesrelativeto the priceof the commodityproduced
in the nonunionsector,and an even lowervalue foraD ensuresthat the
unionreal wage in termsof the now higher-priced commodityproduced
in its own sectorrisesas well.
The conclusionemergesthat it pays a union to increasethe premium
it demandsover nonunionizedlabor unlesstheunionizedsectoris labor-
intensiveand demand elasticitiesare high.
This entirediscussionhas presupposeda consistencyin the ranking
of industriesby physicalfactorproportionsand by distributiveshares.
It is necessaryto take a brieflook at those cases in whichinitialdistor-
severeto cause the industrythat is physically
tion levels are sufficiently
capital-intensiveto pay labor a higherdistributiveshare. With I XI 1
negative, the supply curve must be negatively sloped, as drawn in
figure2. Furthermore,as equation (11) shows, an increase in the pre-
mium paid to union labor in the firstindustry,al/a2, will in this case
shiftthe supplycurve to the right-fromS to S'. The demand curve in
figure2 has been drawn so that a stable equilibriumexists. Above Oa,
excess demand is negative, which would tend to drive price back to
equilibrium.Thus, unlikethe precedingcase, an increasein al,/a2 serves
to depresscommodityl's relativeprice.
This has importantconsequences for the analysis of the impact of
the increasedunion premiumon union real wages. As equations (9) and
(10) reveal,boththe directeffectand the inducedpricechangenow work
in the same direction.It is unambiguouslythe case that a union will
be worse offif it attempts to increase the premiumearned over non-
union labor. There may thus be a limit to the discrepancybetween
union and nonunionwage rates that unions should attemptto achieve.

S
P1 D
P2
a?--
b~~~~~~
0
O ~~~~~~~~~X?
X2
FIG. 2
This would be representedby the difference in the capital-laborratios

in the two industries.If unions in the (physically) capital-intensive
sectordriveup the union-nonunion wage differentialbeyondthis point,
the unionizedsectorwill have a higherdistributiveshare forlabor than
the othersectorand any furtherattemptto raise the spreadwill be self-
defeating.
III
The principalquestionraised by Herbergand Kemp (1971) concernsthe
shape of the (distorted)transformation schedule.This turnsout to be a
difficultquestionto deal withcategorically,even in the highlyrestricted
case in which each production functionexhibits the same constant
elasticityofsubstitution.To open the discussion,I shall treatthegeneral
case and discuss,first,the relationshipbetweenthe price ratio and the
slope of the distortedtransformationschedule. A differentdistorted
transformation scheduleexistsforeach value of al,/a2. This impliesthat,
formovementsalong any given transformation schedule,da = &2 = 0.
Regardlessof the degreeof distortionin factormarkets,competitive
pressuresensure that the value of output, (p1X1 + p2X2), is equal to
the national income,(wjLl + w2L2+ rK). Differentiation of this equal-
ity leads to
(pjdXl + P2dX2)+ (Xidp1+ X2dp2)= (wldL, + w2dL2+ rdK)
+ (Lidw, + L2dw2+ Kdr).

For movementsofX1 and X2 along a transformation schedule,dK equals

zero and, since the aggregatelabor supplyis fixedas well,dL2 = -dL,.
Furthermore,differentiating the competitiveprofitrelations, (3) and
and (4), and multiplyingthe firstby X1 and the second by X2 ensure
the followingequality among the financialvariables:
(X1dp1+ X2dp2)= (Lidw1+ L2dw2+ Kdr)
Subtraction and substitutionleads to the basic relationshipamong
physicalvariables:
(pidXj + P2dX2) = (W1 - W2)dL,.
In the undistortedcase in which wage rates are equated betweensec-

tors,the price-weighted sum of outputchangesalong the transformation
schedulemustvanish,leadingdirectlyto the equalitybetweenthe slope
of the transformation curve and the price ratio. In the distortedcase,
the absolute value of the slope of the transformation curve is shownin
(16). An illustrationof the relationship
-dX2 Pi (w1 - w2) dLj (16)
dXj P2 P2 dX(
betweenslope and price ratio is given in figure3 forthe case w1> w2.
As figure3 illustrates,and the expressionfor (pjdXj + p2dX2) con-
firms,if wi exceeds W2an increasein the output of commodity1 would
raise the value of national income at the distortedcommodityprices,
whose ratio is shown by the line throughA. This depends upon the
assumptionthat w1exceeds w2(taken only forillustration)and the fact
X2
Xl
(W > W2)
FIG. 3

that an expansion of X1 draws labor away fromthe second industry

into the industrywherelabor earns a higherreturn.
This latter phenomenoll,that dL11ldX,is positivealong the transfor-
mation curve,is consistentwith the way contractcurves in production
boxes are usually drawn and hardlymeritsformalproof.However, it
is necessaryto have an explicit representationfor dLl/dX,, and this
is shownin equation (17) :12
dLl a XL2[XK10l + XK2T2I (17)
dXl XK26L + XL26K
This permitsexpression(16) forthe slope of the distortedtransforma-

tion curve to be writtenas (18):
dX2 = 1 - a- 2) O XL2[XK101 + XK2J72I (18)
dXl P2 al [XK26L + XL26K]
Since 6L and 8K themselvesdepend upon elasticitiesof substitution(see

eqq. [5'] and [6']), it may be usefulto give (18') as an alternativeexpres-
sion forthe absolute value of the the slope of the transformation curve:
dX2 -
_ MPi (18')
dXl P2
where
M = 1 - (1 - -) OLl [XK11 +
XK20T21
?
al ai/~ :
l X+XK
KXLX 2
OK1] XK1J71
l] lf +
XK20T2
K ft
The termM representsthe (positive) wedge betweenthe slope and the

priceratio. As alreadynoted,if a2/al is less than unity(that is, industry
1 is unionized),the wedge M is a fractionand the price line is steeper
than the transformation curve.
The difficult questionhas to do withthe curvatureof the transforma-
tion curve. To get at this,differentiate (18') to obtain:
/ dX2\ =_ l
(d-X-) = (P2) + M.
Price changesare relatedto outputchanges(forconstantendowments
and distortions)by (11). Substitutionyields (19):
=X~t x) +Ko (Xi -R 2) (19)

d~
__
L?+ K (X 1- X2)
12
Since LI is aLlXl, dLl/dX, is just aLl { I?+ (dLl/Xl) Withdistortion
levelsand }.
factor endowments constant, both AL, and XI can be expressed in terms of ( -r).
This yields LK1[XjIa
a 1 -
K |
l
XK26L + XL26K
as the expressionfor dLl/dX,. But this simplifiesto (17).

If the expressionin braces is positive,movementalong the transforma-

tion scheduletowardthe horizontalaxis (more Xi) causes the transfor-
mation curve to become steeper.That is, the transformation schedule
is locally bowed out ifand only if
1X1101_+ > 0.
(6L + AK) (Xi X2)
Without specifyingM2/(Xl- X2), this condition seems to convey

littleinformation. However,it does reveal the following:(i) In the un-
distorted case when M_ 1, the transformationschedule must be
bowed out because IXI I0 > 0. (ii) With distortions,thereis a wedge,
M, but if the size of the wedge does not change formovementsalong
the distortedtransformation curve, the local curvatureof that curve
depends preciselyon the very considerationsthat determinewhether
price-outputresponsesare normal or inverse. (iii) Because in general
Al is not zero fora given value of a2/ai,the transformation curve may
locally be bowed in even if price-outputresponsesare normalor bowed
out even ifprice-outputresponsesare perverse.(iv) Since the expression
forthe wedge,M, involves X's, 0's, and ot's,littlein generalcan be said
about the changein the wedge,M.
For the remainderof this section, I intend to pursue partway the
path exploredby Herbergand Kemp in copingwith the problemspre-
sented by (iv). They assume that v is constantin industryi and has
the same value forboth industries.In this special case, the wedge,M,
reducesto:
M=1- 1-(a2/ai)
1+ (XK20K1/XL20L1)
With fixeddistortionlevels,the onlyvariablecomponentof M is the ex-

pressionin the denominator.Along a distortedtransformation curve,
(XK2
OKiN A_
aK1-aL1J- w -r)
) (
- - + (aK2 aL2)
4L2 OL1
- ('1 + 02 - 1)( r-r)
substitutingfor(
Furthermore, r-f) yields:
(XK2Oi1) -6L + ) +
(Ji?J1 0- 1)(X1 - X2)
XL2 0L1 (L+ aK)
This confirmsthe crucialvalue of 2 foreach industry'selasticityof sub-

stitutionfirstdiscoveredby Herbergand Kemp.
Littlenow remainsin obtainingthe expressionforR and substituting
into (19). The resultis shownin expression(20):
_dX2
;= IXl 1?l + -IX 1 -(ai/al)](al + oi-2 )t (Xi *) (20)
dXI I (1/oi)(a2/ai)? (1/CO2)1~ (aL ? 6K) ' (0

where
OK1XK2
OL1XL2 + OK1XK2
and WI + Wi2 =1. The transformation schedule (or distortedlocus of

possible outputs) is locally bowed out if and only if the expressionin
braces is positive.
Several remarkscan be made by inspectionof (20). First, note the
role played by IXI 10. If this should be negative, leading to inverse
price-outputrelationships,thereis a presumptionthat the transforma-
tion scheduleis locallybowed in. This must be the case ifeach a is close
to 2. Second,the termsI XI and (1 - a2/al) shouldbe consideredjointly.
The sign of I X (1 (- a2/ai) indicateswhetherlabor is paid a premium
in the capital-intensiveor the labor-intensiveindustry.For example,
suppose the firstindustryis labor-intensiveso that IX > 0. If labor
receivesa higherreturnin this labor-intensiveindustry, X 1(- a2/ai)
must be positive.Finally,note again the role played by (a1 + a2 - 1).
If labor is paid a premiumin the physicallylabor-intensiveindustry,
simpleresultsemerge.Because labor's distributiveshare must,as well,
be greaterin the unionizedsector, IXI I01 is positive,price-outputre-
lationshipsare normal,and thereis a presumptionthat the transforma-
tionscheduleis bowed out. Since I X (1 - a2/ai) is positivein thiscase,
it clearly follows from (20) that if ai ? a2 > 1 the transformation
schedulemust be bowed out fromthe originover its entirerange. For
smallervalues of a1 + a2, the issue seems to be in doubt. However, as
I prove in the Appendix,regardlessof the value of the commona, the
distortedtransformation schedule must be uniformlybowed out from
the originif labor receivesa premiumin the labor-intensiveindustry.
The othermajor category,in which labor receivesa premiumin the
capital-intensiveindustry,permitsa wider variationof outcomesas to
the curvatureof the distortedtransformation schedule. There are two
subsetsof this categorythat can be characterizedfairlyeasily fromin-
spectionof equation (20). Since X (1 - a2/al) is negative,ifdistortions
are slight enough to leave I X 0 positive, small values for a1 + a2
(that is, less than unity) guaranteea bowed-outshape forthe transfor-
mation schedule. Alternatively,if distortionsare such as to cause the
price-outputresponse to be inverse (that is, X I01 negative) and if
a1 + a2 exceeds unity,the transformation schedulemust be everywhere
bowed in toward the origin.The latter case would include the Cobb-
Douglas example. These remarksserve to focus attentionon the pos-
sibilitythat 1XI01 changes sign from its undistortedpositive value
and that this phenomenommay be linkedto the value of ao.
The Cobb-Douglas case providesa usefulintroductionto this discus-
sion because its paramount feature is the invariance of distributive

sharesto alterationsin factorprices.Suppose that if therewere no dis-

tortionscommodity1 would be labor-intensive.Then labor's share in 1
would exceed labor's sharein 2 not onlyforthat case but also regardless
of distortionsin factormarkets.The only way in which I X I01 could
change signs is for distortionsto alter physical factor proportionsto
make commodity1 capital-intensive.For a sufficiently high premium
paid to labor in the firstindustry,thiscan always be accomplished.This
is most easily seen by referring to figure4, whichis taken fromthe pio-
neeringtreatmentpresentedby Johnson(1966).
In the undistortedcase, productiontakes place at some point on the
distortion-free contractcurve, such as A, with outputs (XO, X2). The
assumptionmade in figure3 is that initiallyXi is labor-intensive(I XI >
0). A small premiumpaid to labor in the labor-intensive industryresults
in a distortedcontractcurve lying in region (3). B could representa
point on such a curve. Johnsonshowed that, forall sets of distortions
leading to contractcurves in region (3), the distortedtransformation
schedulemustlie above the chordjoiningthe end points.If, in addition,
productionfunctionsexhibit the same constant elasticityof substitu-
tion, the transformation schedulemust be everywherebowed out from
the origin.This followsbecause in region(3) labor receivesa premium
in the labor-intensiveindustry.If the second industrywere unionized
instead,productionwould take place at some point such as D in region
(2). Alternatively,if labor in industry1 were to receivea sufficient
pre-
mium,substitutionagainst labor in 1 would proceed to such an extent
that physical factorintensitivesare reversed,such as at point C. In
region (4) labor receives a premiumin the capital-intensiveindustry,
X1, althoughwithoutdistortionsX1 would have been labor-intensive.
Thus, only in region(3), betweenthe contractcurve and the diagonal,
is labor paid a premiumin the labor-intensive industry.
In the Cobb-Douglas case, I01 must remain positive in figure3 re-
gardlessof the degreeof distortion.But IXI is positiveonly if the con-
0101
K ~~~~~CapitalI
Labor
FIG. 4
FIG. 4

tract curve lies below the diagonal (regions[2] and [3]). For a relative
premiumpaid to labor in industry1 of an amount representedby the
ratio of the slopes of the two isoquants along the diagonal, IXI becomes
zero and the distortedtransformation schedule must be equivalent to
the chordjoiningits end points.For lowervalues of a2/al, IXI becomes
negativeand, since ar1+ 'r2 > 1 in the Cobb-Douglas case, the transfor-
mation schedule must be uniformlybowed in toward the origin.It is
forvalues of a2/ai greaterthan unity (region[2], in which,because a2/
to statewhat
al > 1, the unionizedsectoris industry2) that it is difficult
happensto theshape ofthetransformation schedulein the Cobb-Douglas
case. For sufficientlyhigh a2/al, the transformationcurve may be
bowed in locally and may change its curvaturealong the curve. More
preciseconditionsare given by Herbergand Kemp.
The crucialfeatureof the Cobb-Douglas case is the constancyof dis-
tributiveshares, so that X1101 can become negative only by having
XI change signs. In the general CES case, 01 may change signs as
well. Consider,3,as definedin (21):
OL1 OL2
(21)
OK1 OK2
If j3 exceeds unity, labor's distributiveshare is higherin industry1

than in industry2 and 01 is positive. Differentiate(21) to obtain:
( K1) OK2)
Now
(OLi)A
OKL) (7b-r + ('Li-aKi)=(-j(-) + (1- Oi)a
Therefore,
= (02 - ) )2)))2(
In the generalcase, ,3would change with movementsalong any given

distortedcontractcurve. But in the CES case with al = c0.
= (0,- 1) (a2 - a&)
This indicatesnot only that t8remainsconstantalong a distortedcon-

tractcurvebut also how ifchangeswhendistortionschange. In particu-
lar, it reveals that if the commonvalue of vi is less than unity and if
l01 is positivein the undistortedcase wherea2/al is unity,l0 can never
be reducedto zeroby decreasinga2/al. The onlyway to make 01 change
sign is to raise a2/a, above unity. Alternatively,if vi exceeds unity,a
sufficiently low value fora2/aL may cause I01 to change sign.These two
cases are illustratedin figures5 and 6 forvi less than unityand greater
than unity,respectively.

01 ~~~~Capital
Labor _
(I)~~~~~~~4
02
=2<
FIG. 5
Capitol
Labor
(2)
-
?N 2 > I 02
FIG. 6
In bothdiagrams,regions(2), (3), and (4) are as previouslydescribed.

In all of them, I0a is positive. XI is negative in (4) and positive
in (2) and (3). The dotted curve indicatesthe distortedcontractcurve
forwhichi3is unity (or I0 zero). Despite the factthat industriesdiffer
in physical factorproportions,distributiveshares for labor are equal
in 1 and 2 along the dotted curve. The transformation schedule need
not be linear,but movementsalong the schedule do not resultin any
change in commodityprices (because IXI I01 is zero). It is clear from
(20) that the transformationcurvecorresponding to the dottedcontract
curve in figure5 is uniformlybowed out fromthe originif 01 + 02 is
smaller than unity, is linear if al + 02 equals unity, and everywhere
bowedin if oa + 02 exceedsunity(but is less than 2). Pricesand outputs
are inverselyrelatedin region(1) (because 0 I has changedsign) and in
region(4) (because IXI has changedsign).
In figure6 thereis no region(1). Instead, it may be possibleforlabor
to be paid sucha premiumin industry1 thatnot onlyare physicalfactor

proportionsreversedbut, because vi exceedsunity,X2 becomesso labor-

intensivethat labor's distributiveshare in industry2 exceeds its share
in industry1. This is shownby region(5). Along the dotted curve, I0 1
is zero and the transformation schedule is everywherebowed in. For
lowera2/al, I0 I becomesnegativeand, since I XI is also negativein this
range,price-outputresponsesare normal.
It would be possible to extend this discussionof particularcases by
examining(20) in more detail. Instead, I referthe readerto the results
cited by Herbergand Kemp. I conclude this section with several re-
marks. First, note that the case that leads to simple results,in which
labor is paid a premiumin the labor-intensiveindustry,is confinedto
region (3). Second, it is worthremarkingthat generallylow values of
vi are associated with bowed-out transformationschedules. Finally,
note that if distortionsare not too pronounced,so that the distorted
contractcurve lies eitherin region(2) or in region(3), the price-output
responsemust be normal.
IV
Althougha number of differentfacets of the problem presentedby
factormarketdistortionshave been discussedin the precedingsections,
the entireanalysis has been based on the standardtwo-factormodel in
which changes in the degree of distortionhave taken the formof an
exogenouslydeterminedwideningofthe gap betweenwhat a factorlabor
earns in the two sectorsof the economy.This approach may be appro-
priateforcertaintypesof distortions,forexample,whena factorin one
sectoris subject to a tax that is different
fromthat imposedon the same
factorin the othersector(Harberger1962). However,in thosesituations
in whicha factorin one sectorattemptsto improveits positionin real
terms,the primaryweapon used may involve restrictionon entryin-
stead of an attempt to increase the premiumearned over that of the
same factorin otherareas.
Ideally, a model to examine the distortionsproblemin this fashion
would be a three-factor model. In particular,it would be a simplified
model in whichonly two factorsenterinto the productionof any com-
modity.For example,union labor and capital are employedin the first
sectorand nonunionlabor and capital in the second. An increaseddis-
tortionon the part of unions would thus take the formof restricting
labor in the union sector (literallythrowingout labor into the open
marketin a nongrowingeconomy),assumingthis released labor finds
employmentin the nonunionizedsector.In a recentpaper (Jones1971),
I used such a model to explore issues involved in economic history,
capital theory,and trade theory.The virtueof such a model forthe dis-

tortionsproblemlies in its abilityto determineendogenouslywhat the
spread would be betweenunion and nonunionwages. However,instead
of burdeningthis alreadylengthyarticlewithanothermodel,I consider
how the two-sectormodel alreadydiscussedheremightbe reinterpreted
to throwlighton some of the issues involvedin optimalunion strategy
discussedin Section II.
The particularcase I wish to examine is the one in which the union
in the industrythat employsa highercapital-laborratio (say, X1) has
succeeded in drivingup the wage differential to such an extent that
labor's distributiveshare in the unionized sector is higherthan in the
other sector. Whetheror not commodityprices have adjusted to the
union'sattemptto widenthe differential in wage rates,union real wages
wereshownto decreaseby such a move. But what happened to employ-
mentin the unionizedsector?Recall the constructionin figure2, where
an increase in al/a2 shiftedthe relative supply schedule for X1/X2to
the rightand in any eventcaused X1 to expand. Now put thisprocedure
in reverseand assume that the union attemptsto increaseits real wage
by restrictingunion membership.This must reduce X1/X2 and in a
stable marketserve to drive up PI/P2. Such an increasein the relative
price of the commoditythat is in value termslabor-intensivemust in-
creasethe real wage of both unionand nonunionworkers.What is some-
what paradoxical is that nonunionwages are drivenup by more than
unionwages, thus loweringthe (endogenous)spread betweenw1and W2.
But unless the union followsa dog-in-the-manger philosophy,it should
not care about this. As long as it is concernedonly with union real
wages, it would pay to followa restrictivepolicy even if this benefits
nonunionworkerseven morethan union members,both at the expense
of capitalists.
All this has assumed that the unionizedsectoris capital-intensivein
a physicalsense, although it is labor-intensiveby the criterionof dis-
tributiveshares. It restoresfaithin the propositionthat unions should,
in their own interest,followa restrictivepolicy of some sort if their
industryemploysa highercapital-laborratio. If, instead, labor is or-
ganizedin the labor-intensive sector(in physicaltermsand therefore also
in value terms),it may not pay the union to followa restrictivepolicy.
If demand is highlyelastic, it certainlywould not be in the interestof
theunionto limitmembershipartificially and thusraisetheirdifferential,
forthegainerswillbe capitalists.On theotherhand,ifa restrictive policy
can serveto raise substantiallythe relativepriceof the commoditypro-
duced by the union (that is, if demand elasticitiesare low), the union
would gain by limitingmembership.All thisis in accord withthe results
of Section II, for restrictingunion membershipis synonymouswith
wideningthe spread betweenwage rates in the two sectors,whichwas
the parametricformdistortionstook in that sector.

Appendix
The expressionfor(-dX2ldX1) is givenbyequation(20) in thetext.Thetrans-
formationschedulemustbe bowedout iftheexpression in bracketsis positive.
iftheunionized
thatitwillbe positive
I wishtoestablish sectoris labor-intensive.
In such a case, IXI I0 l is positiveas, by assumption,is IXI (1 - a2/al). If the
unionis locatedin the firstsector,both XI and (1 - a2/al) are positive.
Therefore,theexpressionin bracesin (20) couldbe negativeonlyifal + r2is
smallenough.In moredetail,thisrequires:
(al + 072) < - + +
Recall that both IX and I6 are positive. rf(1 - 6

0jw2) is negative,so must
be theentireright-hand side,in whichcase theinequalitycannotbe satisfied
and myassertionis proved.
Therefore,suppose [1 - (I 1 I/2)] is positive.I wishto establishthat
_ 1- (I6(/c2) < a2
1 + (I6I/ci) al
sidemustbe negativeandtheinequality
inwhichcase,ofcourse,theright-hand
To see this,notethat
notsatisfied.
OL2/c2 - I XI (6K1/XL2)
OK26/1 + I X I (6L1/XK2)
Now 1X1 is positiveby assumption,

so that
OL2 W1 OL2 OK1 XK2 a2 XK1 a2
)2 OK2 OK2 OL1 XL2 al XL1 ai
This completes the proofthat,ifhigher-paid in the

unionlaboris established
industry,
labor-intensive thetransformationschedulemustbe bowedout from
theoriginin theCES casein whichal = 02.
References
Bhagwati, J. N., and Srinivasan,T. N. "The Theory of Wage Differentials:
Production Response and Factor Price Equalization." J. Internat.Econ.
(1971): in press.
Harberger,A. C. "The Incidence of the CorporationIncome Tax." J.P.E. 70
(June 1962): 215-40.
Herberg,H., and Kemp, M. C. "Factor Market Distortions,the Shape of the
Locus of CompetitiveOutputs,and the Relation betweenProduct Prices and
Equilibrium Outputs." In Trade, Paymentsand Welfare,papers in interna-
tional economicsin honorof Charles P. Kindleberger,edited by J. N. Bhag-
wati,R. W. Jones,R. A. Mundell,and J. Vanek. Amsterdam:North-Holland,
1971, in press.
Johnson,H. G. "Factor Market Distortionsand the Shape of the Transforma-
tion Curve." Econometrica34 (July1966): 686-98.
Johnson,H. G., and Mieszkowski,P. M. "The Effectsof Unionizationon the

Distributionof Income: A General Equilibrium Approach." Q. J. Econ.

84 (November1970): 539-61.
Jones,R. W. "Factor Proportionsand the Heckscher-OhlinTheorem." Rev.
Econ. Studies24 (October 1956): 1-10.
."The Structureof Simple General Equilibrium Models." J.P.E. 73
(December 1965): 557-72.
"A Three Factor Model in Theory, Trade and History," In Trade,
Paymentsand Welfare,papers in internationaleconomicsin honorof Charles
P. Kindleberger,edited by J. N. Bhagwati, R. W. Jones, R. A. Mundell,
and J. Vanek. Amsterdam:North-Holland,1971,in press,


Distortions in Factor Markets and The General Equilibrium Model of Production Ronald W. Jones

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Distortions in Factor Markets and The General Equilibrium Model of Production Ronald W. Jones

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in FactorMarketsand the

A premiumpaid to a factorof productionin one industryover the

The standard Heckscher-Ohlin model of international trade comprises

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

the transformation schedule may in certain sections become bowed in

n. 1 above), and Bhagwati and Srinivasan (1971).

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

mentrelations,(1) and (2), and the competitivezero-profit

aL1W1 + aKir = piX (3)

Distortionsare assumed to appear only in the labor marketand to take

XKlXl + XK2X2 = K - [XK1aK1 + XK2aK21, (6)

OL2W2 + OK2r = P2 - [6L26L2 + GK26K2] . (8)

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

Therefore,IXI is positiveif and only if the physicallabor-capitalratio

Suppose the firstindustryis, in a physical sense, the capital-intensive

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(for example, commodityprices) may be the opposite of that usually

That is, in the absence of technical progress,the distributive-share

It is a simple matter to combine these two relationshipsto solve

aKl = OLlal(w - r) + OL101al6

These, and the similarcoefficientchanges for industry2, can then be

The firstset of relationshipsI wish to discuss involvesthe mannerin

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This solutionfor(i1 - r) will be used in derivingexpressionsforoutput

(-z =-dA ( Pi P2) +

Two featuresof this solutionneed to be stressed.First, suppose com-

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

firstindustryare exhibitedbelow. These are obtained by solving (7')

Output changescan be derivedby subtracting(6') from(5'):

+ {[XLiKi + XKiOLh07al + [XL2OK2 + XK20L2kf2a&2}-

This expressionconfirmsthe traditionalresultsin trade theorythat at

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

bothindustriesto economizeon laborand to use capital moreintensively.

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cal rankingof factor intensitiescorrespondswith the value ranking.

8"This is equivalent to an underlying assumption that indifferencecurves are

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Set thisequal to the expressionforsupplychangesshownin (11), assum-

wherea 6-L + SK + 1X 0 10D. The a is what has been defined(Jones

Q10a1 + Q2a-2 + QDa-D

From this,it is easy to see that as longas the demandcurveis negatively

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

(-1 P2) = - {OL2Q1O_1+ Q20o2 - OK1OL21X |0D} (I1 a2) (15)

From these expressions,it is clear what union strategyshould be. If

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This would be representedby the difference in the capital-laborratios

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For movementsofX1 and X2 along a transformation schedule,dK equals

In the undistortedcase in which wage rates are equated betweensec-

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

that an expansion of X1 draws labor away fromthe second industry

This permitsexpression(16) forthe slope of the distortedtransforma-

Since 6L and 8K themselvesdepend upon elasticitiesof substitution(see

The termM representsthe (positive) wedge betweenthe slope and the

=X~t x) +Ko (Xi -R 2) (19)

as the expressionfor dLl/dX,. But this simplifiesto (17).

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

If the expressionin braces is positive,movementalong the transforma-

Without specifyingM2/(Xl- X2), this condition seems to convey

With fixeddistortionlevels,the onlyvariablecomponentof M is the ex-

This confirmsthe crucialvalue of 2 foreach industry'selasticityof sub-

This content downloaded from 128.248.155.225 on November 27, 2016 12:04:04 PM

and WI + Wi2 =1. The transformation schedule (or distortedlocus of