PROBLEM SET 4 SOLUTIONS

International Trade
Georgetown University School of Foreign Service in Qatar
Spring 2023

2. In the short-run specific-factors model, examine the impact on a small country following a
natural disaster that decreases its population. Assume that land is specific to agriculture, and
capital is specific to manufacturing, whereas labor is free to move between the two sectors.

a. In a diagram similar to Figure 5-2, determine the impact of the decrease in the
workforce on the output of each industry and the equilibrium wage.
Answer: The following diagram depicts a decrease in population (labor) in the
specific-factors model. The origin for agriculture shifts inward by exactly the amount
of the change in population, carrying with it the curve representing the marginal
product of labor in agriculture. (Note: One could equivalently shift the origin and
MPL curve in manufacturing and arrive at the same result.) The new equilibrium is
determined at the intersection of and ( )′, which corresponds to a
higher wage W’. In manufacturing, the amount of labor decreases from to
and the amount of capital remains the same. As a result, the output of
manufacturing decreases. In agriculture, the amount of labor has decreased from

to (note that ( ) is necessarily less than ( ) and the amount of land

remains the same. As a result, the output of agriculture also decreases).

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 b. What happens to the rentals on capital and land?
Answer: Because the quantity of labor in both industries decreases due to the natural
disaster, the marginal product of labor increases in both industries and the marginal
products of the industry-specific factors decrease. Because it is a small country, the
final output prices and remain unchanged; hence, the rental rate for capital,
MPK, decreases and the rental rate for land, MPT, decreases.

3. How would your answer to Problem 2 change if instead we use the long-run model, with
shoes and computers produced using labor and capital?
Answer: Because now we are thinking about the long-run, we will use the Heckscher-Ohlin
model. In the HO model, factors can move freely between industries. That is why we think
of it as characterizing the long-run.
We have
 Two factors of production (capital and labor) which are freely mobile between two
industries (computers and shoes).
 Shoe production is labor-intensive relative to computer production.
 Price of goods are still fixed (determined by world markets).
We will now show that:
 Output in computers will increase and decrease in shoes
 Wages will remain the same
 Rental on capital will remain the same
With the decrease in labor after the natural disaster, we get the following chain of events:
1. Employment in the labor-intensive shoe industry decreases by the loss in population
following the natural disaster
2. With the decrease in the number of workers per unit of capital in the shoe industry,
MPK declines in shoes.
3. This leads to a decrease in the rental on capital in the shoe industry, which draws
some of the capital in the shoe industry towards the computer industry
4. The movement of capital towards computers lowers the wage in the shoe industry
5. Some labor will also leave the shoe industry due to lower wages

Repeat steps 2-5 until the labor/capital ratio in each industry returns to the pre-migration
level.
The decrease in labor resulting from the natural disaster will be taken out of the shoe
industry. Capital and labor are transferred from shoes to computers, keeping the capital-labor
ratio in both industries unchanged. Note that since labor/capital ratios remain the same,
wages and rental on capital remain the same as well as well.
We can also tell the same story graphically. See graphs below.

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The output of shoes declines in the long run and computer production rises. This is true
because the decrease in labor endowment is absorbed entirely into the labor-intensive
industry. Additional capital and labor from shoes move to computers.
Note that the new PPF is biased against shoes because of the decrease in the endowment
reduces production of shoes disproportionally. Note that the relative price of computers has
not changed.

Point A is the factor allocation before the natural disaster and B is the factor allocation after
the natural disaster.

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4. Consider an increase in the supply of labor due to immigration, and use the long-run
model. Figure 5-10 shows the box diagram and the leftward shift of the origin for the shoe
industry. Redraw this diagram, but instead, shift to the right the origin for computers. That is,
expand the labor axis by the amount , but shift it to the right rather than to the left. With
the new diagram, show how the amount of labor and capital in shoes and computers is
determined, without any change in factor prices. Carefully explain what has happened to the
amount of labor and capital used in each industry and to the output of each industry.
Answer: Keeping factor prices constant (i.e., W and RK constant), the K/L ratio in each
industry remains unchanged. In the diagram below, this means that the slope of the
arrows emanating from each origin stays the same even when the total endowments of
capital or labor change. Shifting the origin for computers to the right expands the
horizontal axis and signifies the increase in labor due to immigration. Finding a new
equilibrium involves scaling the arrows up or down from their respective origins to find a
unique intersection. In this case, the only possible intersection involves lengthening the
shoes arrow and contracting the computers arrow. So, the amount of L and K decreases in
the computer industry but increases in the shoe industry. This illustrates the Rybczynski
theorem: the output of the labor-intensive industry increases with additional labor in the
economy (vice versa for the capital-intensive industry). The new equilibrium is identical
to that in Figure 5-8, so it does not matter to which industry the extra labor is initially
added.