International Economics: Theory and Policy

Eleventh Edition

Chapter 4
Specific Factors and
Income Distribution

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 Chapter Organization

• Introduction
• The Specific Factors Model
• International Trade in the Specific Factors Model
• Income Distribution and the Gains from Trade
• Political Economy of Trade: A Preliminary View
• International Labor Mobility

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 Introduction
• If trade is so good for the economy, why is there such
opposition?

• Two main reasons why international trade has strong

effects on the distribution of income within a country:
1. Resources cannot move immediately or costless from one industry
to another.
2. Industries differ in the factors of production they demand.

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 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.

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 The Specific Factors Model (cont.)

– 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.

 The degree of a factor's specificity is

 Inversely related to the mobility of the
factor, with more mobile factors having
less specificity

 Directly related to the amount of time

required to redeploy the factor to a
different industry

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 The Specific Factors Model (cont.)

• How much of each good does the economy produce?

• The production function for cloth gives the quantity of cloth
that can be produced given any input of capital and labor:
QC = QC (K, LC)

– QC is the output of cloth

– K is the capital stock (Specific Factor)
– LC is the labor force employed in cloth

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 The Specific Factors Model (cont.)

• The production function for food gives the quantity of food

that can be produced given any input of land and labor:

QF = QF (T, LF)

– QF is the output of food

– T is the supply of land (Specific Factor)
– LF is the labor force employed in food

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 Fig. 4-1: The Production Function for Cloth

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 Fig. 4-2: The Marginal Product of Labor

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 Algebraic Measures of Productivity

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 Algebraic Measures of Productivity in Action

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 Production Possibilities (cont.)

• For the economy as a whole, the total labor employed in cloth and food
must equal the total labor supply:
LC + LF = L
• Use these equations to derive the production possibilities frontier of the
economy.

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 Fig. 4-3: The Production Possibility Frontier in
the Specific Factors Model

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 Production Possibilities (cont.)
Output of
Food
c
b
a

Output of Output of Cloth

Food = Slope

Output of Cloth

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 Prices, Wages, and Labor Allocation (cont.)

• The demand curve for labor in the cloth sector:

MPLC x PC = w
– The wage equals the value of the Marginal Revenue Product of labor
in manufacturing.

• The demand curve for labor in the food sector:

MPLF x PF = w
– The wage equals the value of the Marginal Revenue Product of labor
in food.

Value Marginal Revenue Product = MPL i x Pi

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 Fig. 4-4: The Allocation of Labor

Equilibrium

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 Algebraic Measures of Productivity in Action
• Example
• The production function for a competitive firm is Q = K .5L.5. The
firm sells its output at a price of $10, and can hire labor at a
wage of $5. Capital is fixed at one unit and costs $2.

• The maximum profits are??

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 Fig. 4-5: Production in the Specific Factors
Model
Budget
Constraint Line

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 Prices, Wages, and Labor Allocation (cont.)

• What happens to the allocation of labor and the distribution of

income when the prices of food and cloth change?
• Two cases:
1. An equal proportional change in prices
2. A change in relative prices

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 Fig. 4-6: An Equal-Proportional Increase in the Prices of Cloth
and Food

The allocation of
labor between the
two sectors is
unaffected

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 Prices, Wages, and Labor Allocation (cont.)

• When only PC rises:

– Labor shifts from the food sector to the cloth sector and the output of
cloth rises while that of food falls.
– The wage rate (w) does not rise as much as PC since cloth
employment increases and thus the marginal product of labor in that
sector falls.

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 Fig. 4-7: A Rise in the Price of Cloth

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 Prices, Wages, and Labor Allocation (cont.)

• Relative Prices and the Distribution of Income

– Suppose that PC increases by 7%. Then, the wage would
rise by less than 7%.

• What is the economic effect of this price increase on the

incomes of the following three groups?
– Workers?
– Owners of capital?
– Owners of land?

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 Fig. 4-8: The Response of Output to a Change in the
Relative Price of Cloth

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 Fig. 4-9: Determination of Relative Prices

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 Fig. 4-10: Trade and Relative Prices

Home
Pc
Surplus S

Wp
1
P
d

D
Qd
Qc
 For trade to take​place, a country must face a world relative price that is different
from the relative price that would prevail in the absence of trade.
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 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
 Pc = price of Cloth
The value of consumption = Value of Production  Dc = Consumption of C
 Pf = Price of Food
 Df = Consumption of F
 Qc = Production of Clot
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of Foo
 International Trade in the Specific Factors
Model (cont.)

• If we rearrange the equation:

DF - QF = (PC / PF) x (QC – DC )

– Left side of the equation: the amount of Food Imports

– Right side of the equation: the amount of cloth exports x the relative
price of cloth
– The above equation is called the Budget Constraint
– The amount of food imports is constrained by the amount it exports

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 Fig. 4-11: Budget Constraint for a Trading Economy and Gains
from Trade

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 Income Distribution and Trade Politics

• When 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 has ambiguous effects on mobile factors.

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 Income Distribution and Trade Politics (cont.)

• Trade often produces losers as well as winners.

• Optimal trade policy must weigh one group’s gain against
another’s loss.

• Most economists strongly favor free trade.

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 Income Distribution and Trade Politics (cont.)

• Typically, those who gain from trade are a much less concentrated,
informed, and organized group than those who lose.

• Governments usually provide a “safety net” of income support to

cushion the losses to groups hurt by trade (or other changes).
– Trade Adjustment Assistance (TAA)

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 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 2001 to 2010, only about 2% of involuntary displacements
stemmed from import competition or plants moved overseas.

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 Figure 4.12 Unemployment and Import
Penetration in the United States

The highlighted years are recession years, as determined by the National

Bureau of Economic Research.
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 Figure 4.13 U.S. Manufacturing
Employment and Imports from China

Manufacturing employment is measured as a percent of total U.S. non-farm

employment. Imports from China are measured as a percent of the U.S.
manufacturing production.
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 Fig. 4-13: Causes and Effects of International
Labor Mobility

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 Fig. 4-13: Causes and Effects of International
Labor Mobility

 Increase in Productivity in
Foreign Country

Decrease in
Productivity in
Domestic
Country

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 Figure 4.15 Eastern-Western Europe
Relative Compensation 1997–2015
The relative A move towards
income of eastern wage convergence
workers to
western workers

Western Europe includes: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland,
Italy, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom.

Eastern Europe includes: the Czech Republic, Estonia, Hungary, Poland, Slovakia.

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 International Labor Mobility (cont.)
• In the early 20th century, share of immigrants in the U.S. increased
dramatically.
– Vast immigration from Eastern and Southern Europe.

• Tight restrictions on immigration imposed in the 1920s.

– Immigrants were a minor force in the U.S. by the 1960s.

• New wave of immigration began around 1970.

– Mostly from Latin America and Asia.

• As of 2012, 16.1% of the U.S. labor force is foreign-born.

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 Foreign-Born Population as a Percentage of the
U.S. Population

Restrictions on immigration in the 1920s led to a sharp decline in the foreign-born

population in the mid-20th century, but immigration has risen sharply again in
recent decades.
Source: U.S. Census Bureau.
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 Immigration and the U.S. Economy

• The largest increase in recent immigration occurred among

workers with the lowest education levels, making less
educated workers more abundant.
– Possibly reduced wages for native-born workers with low education
levels while raising wages for the more educated
– widening wage gap between less educated workers and highly
educated workers.

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 Figure 4.17 Foreign-Born and Total U.S. Population Over
25 Years Old by Educational Attainment

Relative to native-born workers, foreign-born workers are concentrated in both

the highest and lowest educational groups.
Source: U.S. Census Bureau.
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 Assessment
Question 35 on the Quiz

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 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 without cost 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.

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 Summary (cont.)

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.

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 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.

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 Summary (cont.)

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.

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 Questions

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