Trade, Income Distribution & Globalization: Factors Affecting Wages & Production - Prof. 2, Apuntes de Turismo

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Trade and income distribution

• Ricardo: everybody gains from trade

• Reality: not so simple

• Specific factor model

• Factor proportions theory

American workers.

• Median wages may have decreased in the

period from 1973 to 2005. Remarkable since

GDP per head and productivity has increased.

Average wages have increased.

• 4 explanations

– Ronald Reagan and the Bushs

– Technological change

– Migration

– Trade

Specific factors

• Specific factor: A factor of production that

can only be used in one industry.

• Specific factors versus mobile factors.

• Specific factor and other factors: no clear

distinction.

– Long term

– Short run

Specific factor model

• Two goods, cloth and food

• Three factors of production, L, K (capital)

and T (land, terrain).

• Cloth uses L and K.

• Food uses L and T.

• Q

C=QC(K,LC)

• QF=QF(T,LF)

• L

C+LF=L

Specific factor model,

Production possibilities

• (^) Production function for food is drawn flipped around.
• (^) Production function for food is drawn on its side.
• Lower left quadrant is allocation of labour. It shows the distribution of labour between the two industries. Its slope is -1.
• (^) Upper right quadrant shows production possibility frontier.

Specific factor model,

Production possibilities

• (^) Assume the economy wants to increase output of cloth with one unit.
• (^) Must increase labour input with 1/MPLC units (remember that MPLC is the amount of cloth that one unit of labour creates).
• Each unit of labour taken from food, reduces food production with MPLF units.
• (^) To increase cloth with one unit therefore costs MPLF /MPLC units of food.
• Slope of PPF is - MPLF /MPLC
• (^) This is also the opportunity cost.

Specific factor model,

Production possibilities.

Prices, wages and labour

allocation

• (^) MPL marginal product of labour
• (^) MPL*P value of marginal product of labour
• (^) Hire workers until the value of the value of marginal product of labour is equal to the wage: MPL*P=w
• (^) In our model: MPLCPC=w MPLFPF=w MPL is downward sloping MPL*P is downward sloping and the demand for labour.
• (^) Wages in the two sectors are similar so: MPLCPC=w=MPLFPF

Wages, profits and landrents

• (^) Area under MPL is total production
• (^) Real wages determine how total production is

divided between wages and income for specific

factor.

Prices, wages and labour

allocation

• (^) Remember that wages in the two sectors are similar so: MPLCPC=w=MPLFPF MPLCPC=MPLFPF
• (^) So -MPLF/MPLC = -PC/PF
• (^) At the production point, the production possibility frontier must be tangent to a line whose slope is minus the price of cloth divided by that of food.
• (^) Relationship between relative prices and output:
  • MPLF / MPLC = - PC / PF

Price changes

• Proportional price changes – both prices

increase by proportionally equal amounts.

• Changes in relative prices.

• When prices increase in the same

proportion, no real changes occur.

• Real wages, real profits and real land

rents are the same.

Proportional price changes

Increased prices of cloth

Relative demand and supply

• When PC/PF increases, effects are the same as for increases in PC.
• (^) Increased production of QC and reduced production of QF.
• Therefore, relative supply, RS, is increasing in PC/PF.
• (^) Relative demand is decreasing in PC/PF.