Predict winners and losers of free trade
U.S. Wheat industry expands
Derived demand – farmers use more land and labor
Derived demand – consumers' demand links a businesses' demand for resources
Rental price of land increases, because farmers increase demand for land
The wage rate increases for workers in the wheat industry, because farmers hire more workers
U.S. Land Market Used in Wheat Industry |
U.S. Labor Market Used in Wheat Industry |
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U.S. car industry contracts
Derived demand – firms use less machines and equipment, and less labor
Price of capital decreases, because lower demand for capital
Wage rates for auto workers decreases, because car factory reduce their workforce
U.S. Machines Market Used in Car Industry |
U.S. Labor Market Used in Car Industry |
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Chinese car industry expands
Derived demand – firms use more machines and equipment
Price of capital increases, because higher demand for capital
Chinese wheat industry contracts
Long run effects
Firms can enter or exit an industry
Resources can move between industries
Engage in trade
U.S. Labor Market Used in Wheat Industry |
U.S. Labor Market Used in Car Industry |
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Note – Land will move from car industry to wheat industry in the U.S.; however, the rental price of land will never return to its pre-trade level, because the U.S. was abundant in land used in wheat industry
Chinese car industry expands
Labor migrates from wheat industry to car industry
Derived demand – labor supply shifts left in wheat industry
Labor supply shifts right for car industry
Note – Capital will move from wheat industry to car industry in China; however, the rental price of machines will never return to its pre-trade level, because the China was abundant in capital used in car industry
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1. Stolper-Samuelson Theorem
Real returns to factor resources in the rising price industry experiences higher returns
Real returns to factor resources in the falling price industry experiences lower returns
Example
Equations
Purely competitive markets, P = MC
Pwheat = ar + bw
Pcars = cr + dw
r and w are rental and wage rates respectively
a, b, c, and d are production coefficients
Firm pays for resources that are used to produce one unit of production
Pure trade raises the price of wheat
A higher price causes the rental rate of land to increase
If the price of cars stay the same, then the wage rates must fall
2. Specialized-Factor Pattern
The more specialized a resource is, the more its factor price rises as the product’s price increases
The more specialized a resource is, the more its factor price decreases as the product’s price decreases
Examples
3. The Factor-Price Equalization Theorem - countries that engage in free trade see factor prices equalize
Examples
Wage rates for labor should equalize across trade partners
Land rental rates for land of comparable quality should equalize
Capital rental rates for machines should equalize across trade partners
Why
U.S. is land abundant while China is labor abundant
Free trade expands U.S. wheat production but contracts China’s
Free trade expands car production in China, but contracts U.S.
Reasons why factor prices may not equalize
Countries have different levels of human capital
Countries have different levels of technology
Transportation costs could keep resource prices from being equal
4. Leontief's Paradox
Tested Heckscher-Ohlin Theory
Calculated capital-labor ratios for the United States in 1947
Theory - U.S. should export capital-intensive goods
Reality - U.S. imported capital-intensive goods and exported labor-intensive goods
Aggregation problem – capital and labor are not uniform
Many analysis sums labor and capital together
Labor is not the same in the same industries and countries
Different levels of human capital
5. Results
Some industries follow these theories quite well
U.S. – land abundant; thus it exports agricultural industries
Japan - not abundant in land, so Japan imports agricultural, fish, forestry, and mineral products
Middle East – petroleum abundant; thus, it exports petroleum
China and India – labor abundant; they do export labor-intensive products
Some industries do not follow theories well
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