East Asia New Industrializing Countries Essay

Description

Topic: The evidence cited in the chapter 3 using the examples of the East Asia New Industrializing Countries suggests that as international productivities converge, so do international wage levels. Why do you suppose this happened for the East Asian NICs? In light of your answer, what do you think is likely to happen to the relative wages (relative to those in the United States) of China in the coming decade? Explain your reasoning.

2 attachmentsSlide 1 of 2attachment_1attachment_1attachment_2attachment_2.slider-slide > img { width: 100%; display: block; }
.slider-slide > img:focus { margin: auto; }

Unformatted Attachment Preview

Essay Suggestions for ECO 4703
The expectation of your other classes when writing essays may be different. For this
class, consider yourself as an expert, writing for a daily column. When writing your
essays, consider your audience as the readers of the journal and avoid technical
language or information. Do not use terms such as “Based on Hecksher-Ohlin
Theorem” etc. Do not draw graphs or use mathematical formulations. While avoiding
technical methods to prove your point, you must use scientific results and data with
your interpretation by using words rather than assuming that the facts speak for
themselves, and you must use those scientific results or data whenever you make a
statement or an argument to convince your audience. Also, reserve the use of scientific
and professional words to the key concepts of your manuscript.
Please take the following suggestions into account when writing your essay:
1. Include a reference, link, or citation when appropriate. It is plagiarism to
use other writers’ words and IDEAS.
2. Please do not start your essay by writing “Yes, this is correct” or “I agree” or “I
disagree” etc. You are supposed to write an essay about the topic. It is
not about whether the statement is correct or incorrect or you are
supposed to write an “answer’ to it. It is a topic, and you are supposed
to write an essay, such as a short column in a journal, on that topic. It is
not a “yes” or “no” question that you are supposed to answer. It is a
topic on which you must elaborate, comment, agree or disagree, prove
or disprove without directly answering it.
3. Quotations should generally not be used.
4. Avoid informal language, jargon, and slang. Example: Prefer “It is likely that
…” “It may be the case …” etc. rather than “I believe” or “I think”. Prefer
“conducted a study” instead of “did a study” “examined” instead of “looked at”
“utilize” instead of “use” (where appropriate) “great deal” instead of “a lot”
“furthermore” instead of run-on sentences.
5. Be organized in your thoughts and ideas.
6. Have an introduction, body, and a conclusion.
7. Have a structure and flow in your essay. Do not let your ideas float around.
Use paragraph or sentence correctors as needed.
8. Stay on topic. Make sure you comment on every statement given in the topic.
9. Provide evidence of critical, college-level thinking and thoughtfulness in your
responses or interactions.
10. Avoid summarizing.
11. Be aware of grammar and sentence mechanics.
12. Participation alone is not enough; a thoughtful, meaningful, and respectful
approach in your posts is required.
International Economics: Theory and
Policy
Eleventh Edition
Chapter 3
Labor Productivity
and Comparative
Advantage: The
Ricardian Model
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Learning Objectives
3.1 Explain how the Ricardian model, the most basic model
of international trade, works and how it illustrates the
principle of comparative advantage.
3.2 Demonstrate gains from trade and refute common
fallacies about international trade.
3.3 Describe the empirical evidence that wages reflect
productivity and that trade patterns reflect relative
productivity.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Preview
• Opportunity costs and comparative advantage
• A one-factor economy, the Ricardian model
• Production possibilities
• How world relative demand and supply determine the
relative price after trade
• Gains from trade; Relative wages and trade
• Misconceptions about comparative advantage
• Transportation costs and non-traded goods
• Empirical evidence
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Introduction
• Differences across countries are a key reason why trade
occurs:
– The Ricardian model (Econ/Trade Chapter 3) examines
differences in the productivity of labor (due to
differences in technology) between countries.
– The Specific Factors model (Econ/Trade Chapter 4)
and the Heckscher-Ohlin model (Econ/Trade Chapter
5) examine differences in labor, labor skills, physical
capital, land, or other factors of production between
countries.
• Trade may also arise due to economies of scale (larger
scale of production is more efficient).
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (1 of 6)
• The opportunity cost of producing something measures
the cost of not being able to produce something else with
the resources used.
• Comparative advantage will be determined by comparing
opportunity costs across countries.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (2 of 6)
• A simple example with roses and computers explains the
intuition behind the concepts of opportunity cost and
comparative advantage in the Ricardian model.
• For example, suppose a limited number of workers could
produce either roses or computers.
– The opportunity cost of producing computers is the
amount of roses not produced.
– The opportunity cost of producing roses is the amount
of computers not produced.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (3 of 6)
• Suppose that in the United States 10 million roses could be
produced with the same resources as 100,000 computers.
• Suppose that in Colombia 10 million roses could be
produced with the same resources as 30,000 computers.
• Colombia has a lower opportunity cost of producing roses:
has to stop producing fewer computers in order to free up
resources to make a rose.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (4 of 6)
• A country has a comparative advantage in producing
a good if the opportunity cost of producing that good is
lower in the country than in other countries.
– The United States has a comparative advantage in
computer production.
– Colombia has a comparative advantage in rose
production.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (5 of 6)
• Suppose initially that Colombia produces computers
and the United States produces roses, and that both
countries want to consume computers and roses.
• Can both countries be made better off?
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Table 3.1 Hypothetical Changes in
Production
blank
Million Roses
Thousand Computers
United States
?10
+100
Columbia
+10
?30
0
+70
Total
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
The Concept of Comparative
Advantage (6 of 6)
• When countries specialize in production in which they have
a comparative advantage, more goods and services can
be produced and consumed.
– Have the United States stop growing roses and use
those resources to make 100,000 computers instead.
Have Colombia stop making 30,000 computers and
grow roses instead.
– If produce goods in which have a comparative
advantage (the United States produces computers and
Colombia roses), they could still consume the same 10
million roses, but could consume 100,000 ? 30,000 =
70,000 more computers.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
A One-Factor Economy (1 of 4)
• We formalize these ideas by constructing a one-factor
Ricardian model using the following assumptions:
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
A One-Factor Economy (2 of 4)
1. Labor is the only factor of production.
2. Labor productivity varies across countries due to
differences in technology, but labor productivity in each
country is constant.
3. The supply of labor in each country is constant.
4. Two goods: wine and cheese.
5. Competition allows workers to be paid a wage equal to
the value of what they produce, and allows them to work
in the industry that pays the highest wage.
6. Two countries: home and foreign.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
A One-Factor Economy (3 of 4)
• A unit labor requirement indicates the constant number
of hours of labor required to produce one unit of output.
– aLC is the unit labor requirement for cheese in the home
country. aLC hours of labor produce one pound of
cheese in the home country.
– aLW is the unit labor requirement for wine in the home
country. aLW hours of labor produce one gallon of wine
in the home country.
• A high unit labor requirement means low labor productivity.
– Labor productivity is how much output one hour of
labor creates.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
A One-Factor Economy (4 of 4)
• Labor supply L indicates the total amount of labor
resources ? the number of hours worked (a constant
parameter).
• aLC indicates the amount of labor required for each pound
of cheese produced (a constant).
• Cheese production QC indicates how many total pounds of
cheese that the home country produces.
• aLW indicates the amount of labor required for each gallon
of wine produced (a constant).
• Wine production QW indicates how many total gallons of
wine that the home country produces.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (1 of 6)
• The production possibility frontier (PPF) of an economy
shows the maximum amount of a goods that can be
produced for a fixed amount of resources.
• The production possibility frontier of the home economy is:
aLCQC + aLWQW ? L
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (2 of 6)
L
• Maximum home cheese production is QC =
when Qw = 0.
a LC
• Maximum home wine production is Qw =
L
when Qc = 0.
a Lw
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (3 of 6)
• For example, suppose that the home economy’s labor
supply is 1,000 hours.
– aLC = 1 hours/lb, so 1 hour of labor produces one
pound of cheese in the home country.
– aLW = 2 hours/gallon, so 2 hours of labor produces one
gallon of wine in the home country.
• The PPF equation aLCQC + aLWQW ? L becomes QC + 2QW
? 1,000.
• Maximum cheese production is 1,000 pounds.
• Maximum wine production is 500 gallons.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Figure 3.1 Home’s Production Possibility
Frontier
The line PF shows the maximum amount of cheese Home can
produce given any production of wine, and vice versa.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (4 of 6)
• The opportunity cost of cheese is how many gallons of
wine Home must stop producing in order to make one
more pound of cheese: aLC
aLW
– The opportunity cost is constant because the unit labor
requirements are both constant.
– The opportunity cost of cheese appears as the
absolute value of the slope of the PPF.
? a LC
L
Qw =
??
a Lw ? a Lw
?
? QC
?
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (5 of 6)
• Producing an additional pound of cheese requires aLC
hours of labor.
• Each hour devoted to cheese production could have been
used instead to produce an amount of wine equal to
? 1 ?
1 hour/(aLW hours/gallon of wine) = ?
? gallons of wine
? aLW ?
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Production Possibilities (6 of 6)
• For example, if 1 hour of labor is moved to cheese
production, that additional hour could have produced
? 1?
1 hour/(2 hours/gallon of wine) = ? ? gallon of wine.
?2?
• Opportunity cost of producing one pound of cheese is
1
gallon of wine not produced.
2
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (1 of 7)
• PC is the price of cheese; PW is the price of wine.
• wC is the wage paid to workers who make cheese, and wW
is the wage paid to workers who make wine.
• Due to competition in the labor and goods markets:
– Hourly wages of cheese makers will equal the value of
the cheese produced in an hour: WC = PC
aLC
– Hourly wages of wine makers will equal the value of
the wine produced in an hour: Ww = Pw
aLw
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (2 of 7)
• Workers will choose to work in the industry that pays the
higher wage.
• If the price of cheese relative to the price of wine exceeds
the opportunity cost of producing cheese
PC
aLC
?
,
PW aLW
– Then the wage paid when making cheese will exceed
the wage in wine
PC
PW
WC =
?
= WW
aLC aLW
– So workers will make only cheese (the economy
specializes in cheese production).
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (3 of 7)
• If the price of cheese relative to the price of wine is less
than the opportunity cost of producing cheese
PC
aLC
?
,
PW aLW
– Then the wage in cheese will be less than the wage in
wine
PC
PW
WC =
?
= WW
aLC aLW
– So workers will make only wine (the economy
specializes in wine production).
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (4 of 7)
• If the price of cheese relative to the price of wine equals
the opportunity cost of producing cheese
PC
aLC
=
,
PW aLW
– Then the wage in cheese will equal the wage in wine
PC
PW
WC =
=
= WW
aLC aLW
– So workers will be willing to make both wine and
cheese.
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (5 of 7)
• For example, suppose cheese sells for PC = $4/pound and
wine sells for PW = $7/gallon.
– Wage paid producing cheese is
PC
= ($4/pound)(1 pound/hour) = $4/hour.
aLC
– Wage paid producing wine is
Pw
?1
?
= ($7/gallon) ? gallon/hour ? = $3.50/hour.
aLw
?2
?
– Workers would be willing to make only cheese (the
relative price of cheese 4 exceeds the opportunity cost
1
7
).
of cheese of
2
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (6 of 7)
• If the price of cheese drops to PC = $3/pound:
– Wage paid producing cheese drops to
PC
= ($3/pound)(1 pound/hour) = $3/hour.
aLC
– Wage paid producing wine is still $3.50/hour if price
of wine is still $7/gallon.
– Now workers would be willing to make only wine (the
3
relative price of cheese
is now less than the
7 1
opportunity cost of cheese ).
2
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Relative Prices and Supply (7 of 7)
• If the home country wants to consume both wine and cheese (in
the absence of international trade), relative prices must adjust
so that wages are equal in the wine and cheese industries.
P
P
– If C = W workers will not care whether they work in the
aLC aLW
cheese industry or the wine industry, so that production of
both goods can occur.
– Production (and consumption) of both goods occurs when
the relative price of a good equals the opportunity cost of
producing that good:
PC
a
= LC
PW aLW
Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved
Trade in the Ricardian Model (1 of 4)
• Use “*” to indicate foreign country variables.
• When one country can produce a unit of a good with less
labor than another country, we say that the first country
has an absolute advantage in producing that good.
• If aLC < a*LC , Home labor is more efficient than Foreign in producing cheese. • Does that guarantee that Home should export cheese? Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Trade in the Ricardian Model (2 of 4) • Comparative advantage, not absolute advantage, determines the pattern of trade (more about this distinction later). • Suppose that the home country has a comparative advantage in cheese production: its opportunity cost of producing cheese is lower than in the foreign country. aLC a *LC = aLW a *Lw – When the home country increases cheese production, it reduces wine production less than the foreign country would. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Trade in the Ricardian Model (3 of 4) • Since the slope of the PPF indicates the opportunity cost of cheese in terms of wine, Foreign’s PPF is steeper than Home’s. – To produce one pound of cheese, must stop producing more gallons of wine in Foreign than in Home. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Figure 3.2 Foreign’s Production Possibility Frontier Because Foreign’s relative unit labor requirement in cheese is higher than Home’s (it needs to give up many more units of wine to produce one more unit of cheese), its production possibility frontier is steeper. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Trade in the Ricardian Model (4 of 4) • Before any trade occurs, the relative price of cheese to wine reflects the opportunity cost of cheese in terms of wine in each country. • In the absence of any trade, the relative price of cheese to wine will be higher in Foreign than in Home if Foreign has the higher opportunity cost of cheese. • It will be profitable to ship cheese from Home to Foreign (and wine from Foreign to Home) – where does the relative price of cheese to wine settle? Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (1 of 8) • To see how all countries can benefit from trade, need to find relative prices when trade exists. • First calculate the world relative supply of cheese: the quantity of cheese supplied by all countries relative to the quantity of wine supplied by all countries QC + Q *C RS = QW + Q *W Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (2 of 8) • If the relative price of cheese falls below the opportunity cost of cheese in both countries PC aLC a *LC ? ? , PW aLW a *Lw – No cheese would be produced. – Domestic and foreign workers would be willing to produce only wine (where wage is higher). Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (3 of 8) • When the relative price of cheese equals the opportunity cost in the home country PC aLC a *LC = ? , PW aLW a *Lw – Domestic workers are indifferent about producing wine or cheese (wage when producing wine same as wage when producing cheese). – Foreign workers produce only wine. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (4 of 8) • When the relative price of cheese settles strictly in between the opportunity costs of cheese aLC PC a *LC ? ? , aLW PW a *Lw – Domestic workers produce only cheese (where their wages are higher). – Foreign workers still produce only wine (where their wages are higher). – World relative supply of cheese equals Home’s maximum cheese production divided by Foreign’s maximum wine production L aLC . L * a *LW Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (5 of 8) • When the relative price of cheese equals the opportunity cost in the foreign country aLC PC a *LC ? = , aLW PW a *Lw – Foreign workers are indifferent about producing wine or cheese (wage when producing wine same as wage when producing cheese). – Domestic workers produce only cheese. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (6 of 8) • If the relative price of cheese rises above the opportunity cost of cheese in both countries aLC a *LC PC ? ? , aLW a *Lw PW – No wine is produced. – Domestic and foreign workers are willing to produce only cheese (where wage is higher). Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (7 of 8) • World relative supply is a step function: – First step at relative price of cheese equal to Home’s aLC 1 opportunity cost ,which equals in the example. aLW 2 – Jumps when world relative supply of cheese equals Home’s maximum cheese production divided by Foreign’s L aLC , which equals 1 in the maximum wine production L * a *LW example. – Second step at relative price of cheese equal to Foreign’s opportunity cost a *LC , which equals 2 in the example. a *LW Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Determining the Relative Price after Trade (8 of 8) • Relative demand of cheese is the quantity of cheese demanded in all countries relative to the quantity of wine demanded in all countries. • As the price of cheese relative to the price of wine rises, consumers in all countries will tend to purchase less cheese and more wine so that the relative quantity demanded of cheese falls. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Figure 3.3 World Relative Supply and Demand The RD and RD’ curves show that the demand for cheese relative to wine is a decreasing function of the price of cheese relative to that of wine, while the RS curve shows that the supply of cheese relative to wine is an increasing function of the same relative price. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Gains from Trade (1 of 4) • Gains from trade come from specializing in the type of production which uses resources most efficiently, and using the income generated from that production to buy the goods and services that countries desire. – “Using resources most efficiently” means producing a good in which a country has a comparative advantage. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Gains from Trade (2 of 4) • Domestic workers earn a higher income from cheese production because the relative price of cheese increases with trade. • Foreign workers earn a higher income from wine production because the relative price of cheese decreases with trade (making cheese cheaper) and the relative price of wine increases with trade. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Gains from Trade (3 of 4) • Think of trade as an indirect method of production that converts cheese into wine or vice versa. • Without trade, a country has to allocate resources to produce all of the goods that it wants to consume. • With trade, a country can specialize its production and exchange for the mix of goods that it wants to consume. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Gains from Trade (4 of 4) • Consumption possibilities expand beyond the production possibility frontier when trade is allowed. • With trade, consumption in each country is expanded because world production is expanded when each country specializes in producing the good in which it has a comparative advantage. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Figure 3.4 Trade Expands Consumption Possibilities International trade allows Home and Foreign to consume anywhere within the colored lines, which lie outside the countries’ production frontiers. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved A Numerical Example (1 of 5) Unit labor requirements Home Foreign Cheese Wine aLC = 1 hour/lb aLW = 2 hours/gallon a*LC = 6 hours/lb a*LW = 3 hours/gallon • What is the home country’s opportunity cost of producing cheese? aLC 1 = , to produce one pound of cheese, stop producing aLW 2 1 gallon of wine. 2 Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved A Numerical Example (2 of 5) • The home country is more efficient in both industries, but has a comparative advantage only in cheese production. a *LC 1 aLC = ? =2 2 aLW a *LW • The foreign country is less efficient in both industries, but has a comparative advantage in wine production. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved A Numerical Example (3 of 5) • With trade, the equilibrium relative price of cheese to wine settles between the two opportunity costs of cheese. • Suppose that the intersection of RS and RD occurs at PC = 1 so one pound of cheese trades for one gallon of PW wine. • Trade causes the relative price of cheese to rise in the home country and fall in foreign. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved A Numerical Example (4 of 5) • With trade, the foreign country can buy one pound of PC = one gallon of wine, cheese for PW a *LC = 2 gallons – instead of stopping production of a *LW of wine to free up enough labor to produce one pound of cheese in the absence of trade. – Suppose L* = 3,000. The foreign country can trade its 1,000 gallons maximum production of wine for 1,000 pounds of cheese, instead of the 500 pounds of cheese it could produce itself. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved A Numerical Example (5 of 5) • With trade, the home country can buy one gallon of wine PW = one pound of cheese, for PC aLW = 2 pounds – instead of stopping production of aLC of cheese to free up enough labor to produce one gallon of wine in the absence of trade. • The home country can trade its 1,000 pounds maximum production of cheese for 1,000 gallons of wine, instead of the 500 gallons of wine it could produce itself. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Relative Wages (1 of 5) • Relative wages are the wages of the home country relative to the wages in the foreign country. • Productivity (technological) differences determine relative wage differences across countries. • The home wage relative to the foreign wage will settle in between the ratio of how much better Home is at making cheese and how much better it is at making wine compared to Foreign. • Relative wages cause Home to have a cost advantage in only cheese and Foreign to have a cost advantage in only wine. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Relative Wages (2 of 5) • Suppose that PC = $12/pound and PW = $12/gallon. • Since domestic workers specialize in cheese production after trade, their hourly wages will be PC $12 = = $12 aLC 1 • Since foreign workers specialize in wine production after trade, their hourly wages will be PW $12 = = $4 a *LW 3 • The relative wage of domestic workers is therefore $12 =3 $4 Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Relative Wages (3 of 5) • The relative wage lies between the ratio of the productivities in each industry. 6 – The home country is = 6 times as productive in cheese 1 3 production, but only = 1.5 times as productive in wine 2 production. – The home country has a wage 3 times higher than the foreign country. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Relative Wages (4 of 5) • These relationships imply that both countries have a cost advantage in production. – High wages can be offset by high productivity. – Low productivity can be offset by low wages. • In the home economy, producing one pound of cheese costs $12 (one worker paid $12/hr) but would have cost $24 (six paid $4/hr) in Foreign. • In the foreign economy, producing one gallon of wine costs $12 (three workers paid $4/hr) but would have cost $24 (two paid $12/hr) in Home. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Relative Wages (5 of 5) 1 • Because foreign workers have a wage that is only 3 the wage of domestic workers, they are able to attain a cost advantage in wine production, despite low productivity. • Because domestic workers have a productivity that is 6 times that of foreign workers in cheese production, they are able to attain a cost advantage in cheese production, despite high wages. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Do Wages Reflect Productivity? (1 of 2) • Do relative wages reflect relative productivities of the two countries? • Evidence shows that low wages are associated with low productivity. – Wage of most countries relative to the U.S. is similar to their productivity relative to the U.S. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Productivity and Wages A country’s wage rate is roughly proportional to the country’s productivity Source: International Monetary Fund and The Conference Board. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Do Wages Reflect Productivity? (2 of 2) • Other evidence shows that wages rise as productivity rises. – As recently as 1975, wages in South Korea were only 5% of those of the United States. – As South Korea’s labor productivity rose (to about half of the U.S. level by 2007), so did its wages. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Misconceptions about Comparative Advantage (1 of 3) 1. Free trade is beneficial only if a country is more productive than foreign countries. – But even an unproductive country benefits from free trade by avoiding the high costs for goods that it would otherwise have to produce domestically. – High costs derive from inefficient use of resources. – The benefits of free trade do not depend on absolute advantage, rather they depend on comparative advantage: specializing in industries that use resources most efficiently. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Misconceptions about Comparative Advantage (2 of 3) 2. Free trade with countries that pay low wages hurts high wage countries. – While trade may reduce wages for some workers, thereby affecting the distribution of income within a country, trade benefits consumers and other workers. – Consumers benefit because they can purchase goods more cheaply. – Producers/workers benefit by earning a higher income in the industries that use resources more efficiently, allowing them to earn higher prices and wages. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Misconceptions about Comparative Advantage (3 of 3) 3. Free trade exploits less productive countries whose workers make low wages. – While labor standards in some countries are less than exemplary compared to Western standards, they are so with or without trade. – Are high wages and safe labor practices alternatives to trade? Deeper poverty and exploitation may result without export production. – Consumers benefit from free trade by having access to cheaply (efficiently) produced goods. – Producers/workers benefit from having higher profits/wages—higher compared to the alternative. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Comparative Advantage with Many Goods (1 of 7) • Suppose now there are N goods produced, indexed by i = 1,2,…N. • The home country’s unit labor requirement for good i is aLi, and the corresponding foreign unit labor requirement is a*Li. • Goods will be produced wherever cheapest to produce them. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Comparative Advantage with Many Goods (2 of 7) • Let w represent the wage rate in the home country and w* represent the wage rate in the foreign country. – If waL1 < w*a*L1 then only the home country will produce good 1, since total wage payments are less there. a *L1 w ? , if the relative productivity – Or equivalently, aL1 w* of a country in producing a good is higher than the relative wage, then the good will be produced in that country. Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Table 3.2 Home and Foreign Unit Labor Requirements Relative Home Productivity Advantage aLi*/aLi Home Unit Labor Requirement aLi Foreign Unit Labor Requirement aLi* Apples 1 10 10 Bananas 5 40 8 Caviar 3 12 4 Dates 6 12 2 Enchiladas 12 9 0.75 Good Copyright © 2018, 2015, 2012 Pearson Education, Inc. All Rights Reserved Comparative Advantage with Many Goods (3 of 7) • Suppose there are 5 goods produced in the world: apples, bananas, caviar, dates, and enchiladas. w = 3, the home country will produce apples, bananas, • If w* and caviar, while the foreign country will produce dates and enchiladas. – The relative productivities of the home count