Economics 181: International Trade Spring, 2017 Problem Set 4 Question 1 — Migration and FDI Suppose there are two goods in the world economy: rice (R) and shampoo (S) All countries have the 21same...

Suppose there are two goods in the world economy: rice (R) and shampoo (S) All countries have the

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same production technologies with production functions: YR = L3 K3 and YS = L05K05 Consider

the case of a single country, Mexico, which is endowed with 100 workers and 100 units of capital

1. a) Which sector is capital-intensive?


2. b) Suppose the equilibrium wage-rental rate w is 3 Solve for the labor-capital ratios LR and LS

r2 KR KS

c) Solve for the equilibrium capital and labor used in each sector

1. d) Now suppose that Mexico receives 20 units of Foreign Direct Investment from the US What are the new labor-capital ratios LR and LS ? (Assume that world prices do not change) KR KS


2. e) What are the new levels of capital and labor employed by each sector?


3. f) Without calculating actual quantities produced, can you tell whether Mexico’s production of rice has increased or decreased? Can you tell whether Mexico’s production of shampoo has increased or decreased? Explain


4. g) Now use the production functions and a calculator to solve for the actual quantities produced of each good before and after FDI Do your results confirm your conclusion in the previous part? What theorem does this illustrate? Explain

RR SS

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Department of Economics Spring 2017 Economics 181

1. h) After receiving the FDI from the US, Mexico now receives immigration from Central America How much immigration does Mexico need to receive such that its new production of rice is the same as it was (before the FDI from the US)?


2. i) Suppose that a hurricane in Central America causes much more labor immigration into Mexico than in the previous part so that Mexico now has an endowment of 360 workers to go with its 120 units of capital What are the levels of capital and labor used in each sector? Assuming that international goods prices have not changed, are workers in Mexico better off than before immigration? Are capital-owners better off than before immigration? Explain the differences between this case and the previous ones

Question 2 — Offshoring (Value Chain)

Suppose that there is a continuum [0,1] of production activities (intermediate goods) in which different countries specialize depending on their wages and the costs of offshoring Let ? ? [0, 1] represent the degree of skill intensity of a particular activity with a higher ? (closer to 1) representing a higher level of skill intensity Suppose that the production function for a particular activity is Leontief:

LH LL Q?(LH,LL)=min ? ,1??

so that the unit cost of producing activity with skill intensity ? is: C? =?WH +(1??)WL

where WH and WL are the wages for high- and low-skilled labor respectively
Suppose that there are two countries, Morocco and France Wages in Morocco are WHM = 8 and

WLM =2 WagesinFranceareWHF =9andWLF =3

1. a) Which country has a higher relative wage for high-skilled labor? If offshoring is possible, which country do you expect to specialize in high-skill-intensive activities and which country in low- skill-intensive activities?


2. b) Suppose that there are offshoring costs T = t For any activity with skill intensity ?, what is the unit cost of production for a French company in France? What is the unit cost of production for a French company offshoring the activity to Morocco?


3. c) Assume t = 5 If ? = 1, will a French company choose to perform the activity in France or 33 offshore it to Morocco? If ? = 5, will a French company choose to perform the activity in 6 France or offshore it to Morocco? Explain


4. d) Solve for the threshold value of ? below or above which all activities will be offshored by French companies


5. e) Now suppose the offshoring costs fall to T = 1 What is the new unit cost of production for a 3 French company offshoring the activity to Morocco? Solve for the new threshold of ? below or above which all activities will be offshored by French companies

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Department of Economics Spring 2017 Economics 181

f) How does this reduction in offshoring costs affect the relative demand for high-skilled labor in France? In Morocco? What will happen to the skill premium in France? In Morocco? Illustrate the effects graphically