Factor endowment model
Example:
U.S: Higher capital to labor ratio than mexic
(K/L)us > (K/L)mex
(K/L)beer > (K/L)chips
The price of beer in the U.S. will rise, price in Mexico will fall until they are equal.
Above is referred to as the Factor proportion model.
In the US, wages go down while rents rise. Opposite for mexico.
Gains from trade are unequal.
1954 – First test of these economic theories. Upheld by Gould’s tests in 2000.
1954 study – U.S. in 1947 was capital abundant. This lead to the U.S. importing labor intensive stuff while exporting capital intensive stuff. The study classified the U.S. based on net imports and net exports. Survey discovered that the U.S. was doing the opposite was true: The U.S. was exporting labor while importing capital. This result became a paradox.
Problems in the study:
- Raw materials: Recardo good. Raw materials have a high capital to labor ratio. They show up as labor intensive, thus skewing the result.
- Trade barriers: Tariffs, quotas, etc were imposed on things that were generally labor intensive. These made labor more expensive, thus inflated and less likely to be imported.
- The theory was way too simple and did not factor in enough variables. It did not break down the various types of capital (basic, medium, and high tech) or labor (unskilled, semiskilled, skilled, professional, or scientists). The U.S. does not have comparative advantages exclusively across categories.
- This theory is a “long run” theory. It assumes that technology is transitive and is able to immediately shift between resources. Labor is relatively mobile between the two, however capital is immobile.
MRP = Pb * MPl
The result of these studies was to show that over the long term, labor is mobile across industries while capital is not. In the short run, neither capital nor labor are transferable.
Intermediate effect – The phenomena of workers migrating from lower paying industries to higher ones. This movement shifts the labor supply curves downward for those in higher paying areas, and up from those is lesser paying areas.
Three wage results of trade:
- Nominal wages in the capital intensive country falls (reverse in labor intensive countries).
- Real wage decreases (due to lower nominal wages) IF the person also like beer. The beer is now more expensive, thus coupled with the wage decrease the real wage has fallen. IF the person likes chips instead, Real wages will increase as while wages have fallen, their primary product (imports) are now also cheaper.
Important terms:
Ricardian model
HL model