Republic of the Philippines

Bicol University
College of Business, Economics and Management
Daraga, Albay
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

A. OVERVIEW
This chapter focuses on the effects of international trade to income distribution using the specific
factors model. It includes the following topics:
• Specific Factors Model • Income Distribution and Gains from Trade
• Production Possibilities • Political Economy of Trade
• International Trade in the Specific Factors Model

B. OBJECTIVES

• Learn the basic assumptions and results of the specific factor model.
• Understand international trade in the specific factors model, income distribution and the
gains from trade, the political economy of trade and other details of specific factors.
• Understand existing patterns of international trade using the model.

C. LEARNING OBJECTIVES

Through the course of this topic, the learners shall be able to exhibit understanding of
international trade through appreciation of traditional and specific factor models.

D. INSTRUCTIONS
1. Kindly read and comprehend this topic on Specific Factors and Income Distribution. Bear
with the length of the modules. You need to read in order to learn. However, if some of the
concepts confuse you, I will explain them to you on our next virtual meeting. Do your best to
comprehend. As I’ve said, dreams are unreachable for a motivation too low. Kaya mo yan,
tiwala lang! I’m here to guide you.
2. Watch the video suggestions or read the suggested materials, if there’s any.
3. Prepare the Assignment. The deadline is a week after you receive this module. Send the output
with the filename: ITA_Topic I Output_Course-Year & Block_Surname, First Name,
Middle Initial (ex. ITA_Topic I Output_BS Economics 3B_Garcia, Riza L.)
4. Should you have any questions or concerns, do not to hesitate to send me a message in these
mediums:
a. Private Comment in the Classwork Tab on Google Classroom
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

b. Messenger Group Chat

c. Email at riza.garcia@bicol-u.edu.ph
5. Enjoy your own pace, ‘cause learning is never a race. In these hard and trying times, I
understand that you are walking on a rough patch. Do not forget to pause, breathe, and carry
on! You got this!
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

Welcome back! Make sure to have a full

understanding of chapter 2 before reading this
module. Just a reminder 😊
-Ms. Riza

Why is there opposition to the impacts of trade if it is such a positive thing for the economy?
To understand trade politics, one must examine the impact of trade not just on a nation as a whole,
but also on the distribution of income inside that country.

Trade, according to the concept from chapter 2, leads to international specialization, with
each country moving its labor force from areas where labor is more inefficient to industries where
labor is comparatively more efficient. Individuals will not be harmed by trade since labor is the only
element of production in that paradigm, and it is believed that labor may migrate freely from one industry to another.
As a result, the Ricardian model indicates that not only all nations benefit, but also that every individual benefit from
trade since trade has no effect on income distribution. In practice, however, trade has a significant impact on the
income distribution inside each trading nation, thus the advantages of trade are frequently spread extremely
unevenly.

2 Main reasons why international trade has strong effects on income distribution:
1. Resources cannot move immediately or without cost from one industry to another—a short-run
consequence of trade.
2. Industries differ in the factors of production they demand.

While trade may help a country as a whole, it frequently harms important groups within the country in
the short run and, possibly, but to a lesser amount, in the long run. A genuine trade study must go beyond the Ricardian
model and consider how trade affects income distribution. This chapter focuses on the short-run effects of trade on
income distribution when sources of production cannot move freely between sectors. To keep our model simple,
we assume that the cost of sector switching for some variables is so large that such a transition is unfeasible in the
near run. These elements are unique to a certain industry.

SPECIFIC FACTORS MODEL

The specific factors model was developed by Paul Samuelson and Ronald Jones. Like the simple Ricardian
model, it assumes an economy that produces two goods and that can allocate its labor supply between the two
sectors. Unlike the Ricardian model, however, the specific factors model allows for the existence of factors of
production besides labor. Whereas labor is a mobile factor that can move between sectors, these other factors are
assumed to be specific. That is, they can be used only in the production of particular goods.

Imagine an economy that can produce two goods, manufactures 👚 and food 🍲. Instead of one factor of
production, however, the country has three: labor (L), capital (K), and land (T for terrain).

Factors of production of manufactures 👚 Labor is therefore a mobile factor

• Labor (L) that can be used in either sector,
• Capital (K) while land and capital are both
Factors of production of food 🍲 specific factors that can be used only
• Labor (L) in the production of one good.
• Land (T)
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

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 that tells
us the quantity of manufactures that can be produced given any input of capital and labor.

Production Function for manufactures 👚 Production Function for food 🍲

QM = QM (K, LM) QF = QF (T, LM)
Where: Where:

QM economy’s output of manufactures QF economy’s output of food

K economy’s capital stock T economy’s supply of land

LM labor force employed in manufactures LF labor force employed in food production

For the economy as a whole,

the labor employed must equal the total labor supply L:
LM+LF=L

PRODUCTION POSSIBILITIES

The specific factors model assumes that each of the specific

factors capital and land can be used in only one sector, manufactures
and food, respectively. Only labor can be used in either sector. Thus,
to analyze the economy's production possibilities, we need only to ask
how the economy's mix of output changes as labor is shifted from
one sector to the other.

The more labor that is employed in the production of

manufactures, the larger the output. As a result of diminishing
returns, however, each successive person-hour increases output by
less than the previous one; this is shown by the fact that the curve
relating labor input to output gets flatter at higher levels of
employment.

Assumptions of the Specific Factors Model

(i) There are two commodities X and Y.
(ii) There are two countries A and B.
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

(iii) Land, labor and capital are the three factors. The factor land is specific to the production of X commodity.
The factor capital is specific to the production of Y. The factor labor is used in the production of both X and
Y commodities and it is mobile within the two industries in both the countries.
(iv) There are the conditions of perfect competition in the commodity and factor markets.
(v) There is greater use of labor in country B than in country A.
(vi) Marginal physical product of labor diminishes as the input of labor is increased.
(vii) There are identical production techniques in the two countries.
(viii) Tastes and preferences of the consumers are identical in the two countries.

Since country B makes more use of labor than A, it

suggests that B is relatively more labor- abundant than
country A. On this basis, the production possibility curve of
country A is AA1 and that of country B is BB1 as shown in the
graph Commodity X is land-specific and labor-intensive. The
commodity Y is capital-specific and less labor-intensive. The
slopes of the two production possibility curves show that
country A has comparative advantage in the production of Y
whereas country B has the comparative advantage in the
production of X.

I is the common community indifference curve

(graphical representation of a combined products that gives
similar kind of satisfaction to a consumer thereby making
them indifferent) both the countries. Before trade, R is the
point of production and consumption equilibrium for country
A. S is the point of consumption and production equilibrium for country B. The domestic price ratio in country A is
represented by the slope of the line P0P0 and that of country B is represented by the slope of line P1P1.

These lines indicate that commodity X is relatively cheap in country B than in country A and commodity Y
is relatively cheap in country A than in country B. As trade commences, the capital-specific country will export its
relatively cheap and capital-intensive commodity Y. The land- specific country B, on the other hand, will export its
relatively cheap and labor-intensive commodity X.
As regards the gain from trade for the specific and mobile factors, the factor specific to the export sector
gains and the other immobile factor loses. The mobile factor gains in terms of one commodity and loses in terms of
the other commodity so that overall, its position may remain almost unchanged.

Feeling confused yet? If so, reread the

content and try to absorb it again after
having a break.
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

INTERNATIONAL TRADE IN THE SPECIFIC FACTORS

MODEL
Imagine that two countries, Japan and America, trade with each other; let's examine the effects of this trade
on their welfare. For trade to take place, the two countries must differ in the relative price of manufactures that
would prevail in the absence of trade. Japan and America could have different relative prices of manufactures either
because they differ in their relative demand or because they differ in their relative supply. We will assume away
demand differences: that is, we assume that at any given PM/PF, relative demand is the same in the two countries. If
both countries face the same relative price of manufactures, they will consume food and manufactures in the
same proportions. Thus, both countries will have the same relative demand curve. We will therefore focus on
differences in relative supply as the source of international trade.

Resources and Relative Supply - The basic relationship between resources and relative supply
is straightforward: A country with a lot of capital and not much land will tend to produce a high
ratio of manufactures to food at any given prices, while a country with a lot of land and not
much capital will do the reverse.
Trade and Relative Prices - When the two countries open trade, they create an integrated
world economy whose production of manufactures and food is the sum of the national outputs
of the two goods. The world relative supply of manufactures lies between the relative supplies
in the two countries. The world relative price of manufactures therefore lies between the
national pre-trade prices.

INCOME DISTRIBUTION & THE GAINS FROM TRADE

• Trade benefits the factor

that is specific to the export
sector of each country but hurts
the factor specific to the
import-competing sectors, with
ambiguous effects on mobile
factors. To assess the effects of
trade on particular groups, the
key point is that international
trade shifts the relative price
of manufactures and food.
Consider first what happens in
Japan. We are assuming that in
the absence of trade, Japan
would have had a lower relative
price of manufactures than the
rest of the world. If this is the
case, trade, which leads to a
convergence of relative prices, will mean a rise in PM/PF. In Japan, the result of a rise in PM/PF is that
 Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay

owners of capital are better off, workers experience an ambiguous shift in their position, and landowners are
worse off. In America, the effect of trade on relative prices is just the reverse: The relative price of
manufactures falls. So, in America landowners are better off and capital owners worse off, and the effect on
workers is once again ambiguous.

• A better way to assess the overall gains from trade is to ask a different question: Could those who gain from
trade compensate those who lose, and still be better off themselves? If so, then trade is potentially a source
of gain to everyone.
To illustrate that trade is a source of potential gain for everyone:
1. Notice that in the absence of trade the economy would have to produce what it consumed, and vice versa.
Thus, the consumption of the economy in the absence of trade would have to be a point on the production
possibility frontier.
2. Also notice that it is possible for a trading economy to consume more of both goods than it would have
in the absence of trade.
3. Observe that if the economy as a whole consumes more of both goods, then it is possible in principle to
give each individual more of both goods. This would make everyone better off.

POLITICAL ECONOMY OF TRADE

There are two ways to look at trade policy (or any government policy):
1. Optimal Trade Policy - Suppose a government wants to maximize the welfare of its population. If
everyone were exactly the same in tastes and in income there would be a straightforward solution: The
government would choose policies that make the representative individual as well off as possible. In this
homogeneous economy, free international trade would clearly serve the government's objective. When people
are not exactly alike, however, the government's problem is less well defined. The government must
somehow weigh one person's gain against another person's loss.
2. Income Distribution and Trade Politics - In most countries, those who want trade limitedly are more
effective politically than those who want it extended. Typically, those who gain from trade in any particular
product are a much less concentrated, informed, and organized group than those who lose.

E. SUGGESTED READINGS/VIDEO MATERIALS

None for this module. Let’s have an interactive session next week.

F. REFERENCE

Krugman , P., Obstfeld , M., & Melitz, M. (2018). International Economics, Theory and Policy .
Pearson.
Dixit and Norman. (1980). Theory of International Trade. Cambridge: Cambridge University
Press
Mankiw, N. (2012). Principles of Economic. Pasig City: Cengage Learning Asia Pte Ltd.
Philippine Branch.
Republic of the Philippines
Bicol University
College of Business, Economics and Management
Daraga, Albay