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Chapter 3

Chapter 3. Specific Factors and Income Distribution. The Specific Factor Model. Assumptions of Specific Factor Model. Assume that we are dealing with one economy that can produce two goods, manufactures and food .

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Chapter 3

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  1. Chapter 3 Specific Factors and Income Distribution Chapter 3: Specific Modeland Income Distribution

  2. The Specific Factor Model

  3. Assumptions of Specific Factor Model • Assume that we are dealing with one economy that can produce two goods, manufactures and food. • There are three factors of production; labor (L), capital (K) and land (T for terrain). • Manufactures are produced using capital and labor (but not land). • Food is produced using land and labor (but not capital). • Perfect Competition prevails in all markets.

  4. Assumptions of Specific Factor Model • How much of each good does the economy produce? • The economy’s output of manufactures depends on how much capital and labor are used in that sector. • This relationship is summarized by a production function（生产函数）that tells us the quantity of manufactures that can be producedgiven any input of capital and labor. Chapter 3: Specific Modeland Income Distribution

  5. Assumptions of Specific Factor Model • The production function for manufactures can be summarized algebraically as QM = QM ( K, LM ) where: • QM is the economy’s output of manufactures • K is the economy’s capital stock • LM is the labor force employed in manufactures • Similarly, for food we can write the production function QF = QF ( T, LF ) where: • QF is the economy’s output of food • T is the economy’s supply of land • LF is the labor force employed in food Chapter 3: Specific Modeland Income Distribution

  6. Output, QM QM = QM ( K, LM ) Labor input, LM Production Possibilities Figure 3-1: The Production Function for Manufactures Diminishing returns, because adding a workers means that each worker has less capital to work with. Each successive increment of labor will add less to production than the last. Chapter 3: Specific Modeland Income Distribution

  7. Marginal product of labor, MPLM MPLM Labor input, LM Figure 3-2: The Marginal Product of Labor Chapter 3: Specific Modeland Income Distribution

  8. Assumptions of Specific Factor Model • The full employment of labor condition requires that the economy-wide supply of labor must equal the labor employed in food plus the labor employed in manufactures: LM + LF = L • We can use these equations and derive the production possibilities frontierof the economy. Chapter 3: Specific Modeland Income Distribution

  9. Output of food, QF (increasing ) 1' 2' QF =QF(K, LF) Q2F 3' L2F PP Output of manufactures, QM (increasing ) Labor input in food, LF (increasing ) L Q2M L2M 1 2 3 L AA Labor input in manufactures, LM (increasing ) QM =QM(K, LM) Figure 3-3: The Production Possibility Frontier in the Specific Factors Model Economy’s production possibility frontier (PPF) Production function for food Production function for manufactures Economy’s allocation of labor (AA)

  10. Production possibilities Output of food, QF 1 2 3 Output of manufactures, QM

  11. Production Possibilities • The conclusion of the production possibility frontier in the specific factors model • The curvature of PPF reflects a diminishing returns to labor in each sector—— these diminishing returns are the crucial difference between the specific factors and the Ricardian models. • The absolute value of slope of PPF measures the opportunity cost of manufactures in terms of food —— that is the number of units of food output that must be sacrificed to increase manufactures output by one unit |－ MPLF /MPLM |= MPLF /MPLM

  12. Wage rate, W Wage rate, W PFX MPLF (Demand curve for labor in food) 1 W1 PMX MPLM (Demand curve for labor in manufacturing) Labor used in manufactures, LM Labor used in food, LF L1M L1F Total labor supply, L Figure 3-4: The Allocation of Labor

  13. Relative prices and the distribution of income • Owners of capital, however, are definitely better off.The real wage rate in terms of manufactures has fallen, so that the profits of capital owners in terms of what they produce rises. • Conversely, landowner are definitely worse off.They lose for two reasons: The real wage in terms of food rises, squeezing their income, and the rise in manufactures prices reduces the purchasing power of any given income.

  14. Output of food, QF Q1F 1 PP Output of manufactures, QM Q1M Slope = －(PM /PF)

  15. Output of food, QF Q1F 1 Q2F 2 PP Q2M Output of manufactures, QM Q1M Figure 3-8: The Response of Output to a Change in the Relative Price of Manufactures Slope = －(PM/PF)1 Slope = －(PM /PF) 2

  16. Relative price of manufactures, PM/PF RS E (PM /PF)* RD Relative quantity of manufactures, QM / QF (QM /QF )* Figure 3-9: Determination of Relative Prices

  17. International Trade in the Specific Factors Model Chapter 3: Specific Modeland Income Distribution

  18. Assumptions of the model • Assume that both countries (Japan and America) have the same relative demand curve. • therefore, the only source of international trade is the differences in relative supply. The relative supply might differ because the countries could differ in: • Technology • Factors of production (capital, land, labor) Chapter 3: Specific Modeland Income Distribution

  19. Wage rate, W Wage rate, W PF1 X MPLF Increase in capital stock, K 2 W2 PMX MPLM2 1 W1 PMX MPLM1 Labor used in food, LF Labor used in manufactures, LM Amount of labor shifted from food to manufactures Figure 3-10: Changing the Capital Stock

  20. Relative price of manufactures, PM /PF RS1 RS2 (PM/PF) (QM/QF)1 (QM/QF)2 Relative quantity of manufactures, QM/QF

  21. Relative price of manufactures, PM /PF RSA RSJ (PM/PF) (QM/QF)A Relative quantity of manufactures, QM/QF (QM/QF)J Figure 3-11: Trade and Relative Prices

  22. Relative price of manufactures, PM /PF RSA RSJ (PM/PF )A (PM/PF)J RDWORLD Relative quantity of manufactures, QM/QF Figure 3-11: Trade and Relative Prices

  23. Relative price of manufactures, PM /PF RSA RSWORLD (PM/PF )A RSJ (PM /PF )W (PM/PF)J RDWORLD Relative quantity of manufactures, QM/QF Figure 3-11: Trade and Relative Prices Chapter 3: Specific Modeland Income Distribution

  24. Consumption of food, DF Output of food, QF 2 1 Budget constraint (slope = －PM/PF) Q1F PP Consumption of manufactures, DM Output of manufactures, QM Q1M Figure 3-14: Trade Expands the Economy’s Consumption Possibilities PP’ Chapter 3: Specific Modeland Income Distribution

  25. The End of This Chapter THANK YOU !

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