Marina Hernández Salado International Business Degree

PROBLEM SET 3
1. Go back to the numerical example with no factor substitution that leads to the production
possibility frontier in Figure 5-1.
a) What is the range for the relative price of cloth such that the economy produces both cloth
and food? Which good is produced if the relative price is outside of this range?
aKC = 2
aLC = 2
aKF = 3
aLF = 1

L = 2,000
K = 3,000

Each unit of cloth is produced with 2 units of capital and 2 units of labor. Each unit of food is produced
with 3 units of capital and 1 unit of labor. Furthermore, the economy is endowed with 2,000 units of
labor and 3,000 units of capital. Given these values, we can define the following constraints:

akc Qc + akf QF ≤ 3,000;

2Qc + 3QF ≤ 3,000 -> capital constraint

alc Q c + alf QF ≤ 2,000;

2Qc + 1QF ≤ 2,000 -> labor constraint

The opportunity cost of cloth is given by the slopes of the two components of the production
possibilities frontier, above 2/3 and 2. When cloth production is low, the economy will be using
relatively more labor to produce cloth, and the opportunity cost of cloth is 2/3 a unit of food. However,
as cloth production rises, the economy runs scarce on labor and must take capital away from food
production, raising the opportunity cost of cloth.

As long as relative price of cloth lies between 2/3 and 2 units of food, the economy will produce both
goods. If the price of cloth falls below 2/3, then the economy should completely specialize in food
production (too low a compensation for producing cloth). If the price of cloth rises above 2, complete
specialization in cloth occurs (too low a compensation for producing food).

For parts (b) through (f), assume the price range is such that both goods are produced.

b) Write down the unit cost of producing one yard of cloth and one calorie of food as a function
of the price of one machine-hour, r, and one work-hour, w. In a competitive market, those
costs will be equal to the prices of cloth and food. Solve for the factor prices r and w.

One unit of cloth is produced using 2 units of capital and 2 units of labor, so that
Qc = 2K + 2L → PC = 2r + 2w → 750 = 2r + 2w

One unit of food is produced with 3 units of capital and 1unit of labor, so that
Qf = 3K + 1L → PF = 3r + w → 500 = 3r + w

Then, we can isolate w variable in one function and substitute it in the other function:
PF = 3r + w → w = PF − 3r

PC = 2r + 2(PF − 3r) = 2r + 2PF − 6r = 2PF − 4r

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 Marina Hernández Salado International Business Degree

2PF − PC 2 x 500 − 750

r= = = 62,5
4 4

2PF − PC
w = PF − 3 ( ) = 3PC − 2PF = 3x750 − 2x500 = 1250
4

c) What happens to those factor prices when the price of cloth rises? Who gains and who loses
from this change in the price of cloth? Why? Do those changes conform to the changes
described for the case with factor substitution?
2PF−PC
Looking at the two expressions r = 4 and w = 3PC − 2PF, we can observe that an increase in
the price of cloth will cause an increase in the cost of one work-hour (increase in wages) but a fall in
the price of one machine-hour. Cloths is a labor intensive good, so an increase in its price will lead to
greater production of cloth and an increase in demand for the factor it uses intensively-labor.

d) Now assume the economy’s supply of machine-hours increases from 3,000 to 4,000. Derive
the new production possibility frontier.
akc Qc + akf QF ≤ 4,000;
2Qc + 3QF ≤ 4,000

Solving for QF, Q F ≤ (4,000 − 2Qc )/3

The minimum price of cloth is also unchanged at 2/3 units of goods. The new production possibilities
4,000
frontier will intercept the x-axis at 2,000 instead of 1,500 (Qc = 2 = 2,000).

e) How much cloth and food will the economy produce after this increase in its capital supply?
QF = (4,000 − 2Qc )/3
QF = 2,000 − 2Qc

4,000 − 2Qc
2,000 − 2Qc =
3
4,000 − 2Qc = 6,000 − 6Qc
Qc = 500

QF = 2,000 − 2 (500)
QF = 1,000

After the increase in capital supply, the economy will produce 500 units of cloth and 1,000 units of food.

f) Describe how the allocation of machine-hours and work-hours between the cloth and food
sectors changes. Do those changes conform with the changes described for the case with factor
substitution?

Qc = 2K + 2L → PC = 2r + 2w → 500 = 2𝑟 + 2𝑤
Qf = 3K + 1L → PF = 3r + w → 1,000 = 3𝑟 + 𝑤

PF = 3r + w → w = PF − 3r

PC = 2r + 2(PF − 3r)
PC = 2r + 2PF − 6r
PC = 2PF − 4r

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 Marina Hernández Salado International Business Degree

2PF − PC
r=
4
2 x 1,000 − 500
𝑟 =
4
𝑟 = 375

2PF − PC
w = PF − 3 ( )
4
𝑤 = 3PC − 2PF
w = 3x500 − 2x1,000
w = −500

Prior the increase in supply, where 2Qc + 3QF ≤ 3,000 and 2Qc + 1QF ≤ 2,000, the economy was
producing Q F = 500 and Qc = 750. After the increase the economy is producing
QF = 1,000 and Qc = 500 , production of food has increased whereas cloth production has fell to 500
units. Moreover, looking deeper into the allocation of machine-hours and work hours between cloth
and food sectors, we can observe the following changes: the rental rate of capital has increased from
62,5 to 375, while the wage rate of labor has decreased from 1250 to -500.

2. Suppose in the year 2013, Australia had a population of 45 million and its capital stock is US $90,000
million, and the corresponding figure for Malaysia is 30 million and US $75,000 million. Answer the
following, on the basis of this information:
a) Which country is capital abundant and why?

Capital 90,000
Australia’s ratio: Population = = 0,002
45 m

Capital 75,000
Malaysia’s ratio: Population = = 0,0025
30 m

Malaysia has a relative abundance of capital because a higher relative rate and Australia has relative
abundance in labor.

b) If production of cloth is labor intensive relative to the production of computers, which

country would export cloth, if engaged in trade?
Given the HO model that predicts that the country that is abundant in a factor exports the goods
production is intensive in that factor, Australia will export cloths and Malaysia computers.

3. “The world’s poorest countries cannot find anything to export. There is no resource that is abundant—certainly
not capital or land, and in small poor nations not even labor is abundant.” Discuss.
What matters is not the absolute abundance of factors but the relative abundance, Poor countries have an
abundance of labor relative to capital when compared to more developed countries. Let’s explain it with an
example: suppose the Congo as a small poor country and US as a rich large country. US has more resources, capital
and labor than the Republic of Congo, but what we should actually look at is the relative abundance of these
factors. Congo would have a higher rate of labor relative to capital, showing low levels of capital in comparison of
labor and reflecting a relative abundance of capital in US. This makes labor relatively cheaper and capital more
expensive in Congo than in US.

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### How is the Outsourcing of Programming Jobs Possible Amidst Rising Skilled Labor
Wages in the US?

答案

1. **Comparative Advantage**: One of the fundamental principles in international trade

theory is the concept of comparative advantage. This principle posits that countries (or
entities) will specialize in producing goods or services for which they have a lower
opportunity cost. India, with its large pool of skilled programmers and lower cost of living,
can offer programming services more cost-effectively than the United States, leading
companies to outsource these jobs.

2. **Global Wage Differentials**: While the average wage for skilled labor in the United States
might be rising, this doesn't negate the fact that there are significant wage differentials on a
global scale. Skilled programmers in developing countries may accept lower wages than their
US counterparts due to differences in living costs, exchange rates, and local economic
conditions. This makes outsourcing a financially attractive option for US companies seeking
to reduce costs.

3. **Technology and Globalization**: Advances in technology and the globalization of

services have made it easier for companies to distribute work across the globe. The digital
nature of programming work allows it to be performed anywhere there is internet access,
breaking down the geographical barriers that once limited such activities.

### Arguments Against Blocking Outsourcing of Computer Programming

答案

1. **Efficiency and Consumer Benefits**: Trade economists would argue that outsourcing can
lead to more efficient global allocation of resources, in line with the principle of comparative
advantage. This efficiency can reduce costs for companies, leading to lower prices for
consumers and potentially greater innovation in products and services.

2. **Retaliation and Trade Wars**: Imposing restrictions on outsourcing could lead to

retaliation from other countries, potentially sparking trade wars. Such conflicts can harm the
broader economy by making imports more expensive and limiting exports, thus affecting
many more jobs beyond the programming sector.
3. **Dynamic Labor Markets**: Economists might also highlight the dynamic nature of labor
markets. While outsourcing may negatively impact certain jobs in the short term, it can also
lead to the creation of new opportunities as resources are reallocated. The focus should be
on facilitating this transition through policies that support education, training, and mobility
of labor.

4. **Global Welfare and Development**: From a broader perspective, outsourcing can

contribute to development in lower-income countries, helping to raise incomes and improve
living standards. This can lead to a more balanced global economy and, in the long run,
create new markets for US goods and services.

All in all, while the outsourcing of computer programming jobs to countries like India poses
challenges for some workers in the United States, the overall economic rationale lies in the
principles of comparative advantage and the potential for efficiency gains. Trade economists
would argue for addressing the specific challenges through targeted domestic policies rather
than blocking outsourcing, which could have broader negative implications for the economy.
The Heckscher-Ohlin (H-O) model is a fundamental model in international trade theory that
predicts trade patterns based on countries' relative factor endowments. The model suggests
that countries will export goods that intensively use their abundant factors and import goods
that intensively use their scarce factors. A key theorem within this framework is the Factor-
Price Equalization theorem, which states that free trade will lead to the equalization of the
price of factors of production (like labor and capital) across countries, as long as certain
assumptions are met, such as identical technologies and no barriers to trade.

However, empirical work has shown that factors of production such as labor and capital are
not equally efficient across countries—this is due to differences in technology, human capital
(such as education and experience), institutional frameworks, and other productivity-related
factors. This reality challenges the assumption of the H-O model that factors of production
are homogeneous and thus comparably productive internationally.

Here is how differing factor efficiencies affect the concept of factor-price equalization:

1. **Technology and Productivity Differences**: If one country has more advanced

technology or higher productivity, its factors of production are more efficient. This implies
that even with free trade, factor prices may not equalize because these differences can lead
to higher productivity, and thus higher returns to the more efficient factors.

2. **Factor Quality and Human Capital**: Factors like labor are not identical across countries.
A unit of labor in one country may have different levels of education, skills, or experience
compared to a unit of labor in another country. The H-O model's assumption of identical
factor quality is violated, and hence factor prices may not equalize through trade.

3. **Institutional and Structural Differences**: Variations in institutional structures, legal

systems, infrastructure, and social norms can also affect the efficiency of factors. For
example, more efficient financial markets or better property rights enforcement can increase
the productivity of capital. These institutional differences mean factor prices can remain
different even if countries trade freely.

4. **Adjustment Costs and Mobility**: Even when trade leads to a change in factor demands,
adjustment costs and factor mobility can prevent the equalization of factor prices. Workers
may not be able or willing to move to where their factor is in higher demand, and capital may
face barriers to movement, such as regulatory restrictions.

In light of these differences, empirical evidence suggests that while free trade under the H-O
framework can lead to some convergence of factor prices, complete equalization is unlikely.
Factors of production are not perfectly substitutable across borders due to efficiency
differences and other barriers, leading to persistent differences in factor prices between
countries. This finding has important policy implications, suggesting that trade alone may
not be sufficient to fully equalize incomes or economic conditions across countries, and
highlighting the need for complementary policies that address factor efficiency and mobility.