Question

You are a senior manager of a firm in Florida that manufactures a range of toys locally only. Your revenues come from two products- plastic toys with no moving parts, requiring simple assembly, and electric toys with moving parts, requiring precision & skilled assembly. Your CEO has made a recent trip to Asia and has discovered the wonderful world of low labor cost South East Asian countries. She concludes that the company should shift production of part of their products at least to some of these countries, reckoning that the company could cut production costs substantially. After further research, she discovered that labor costs in Pakistan are Rs.100 per hour compared to $9 in Florida. When she learnt that the current exchange rate is Rs.20/$, she was convinced that she should move all production to Pakistan.

You, however, have had the benefit of attending the international business course at Nova, and so investigate further before carrying out the CEO's bidding. You determine that your CEO was right about the labor cost differences being the single most important determinant of your costs. Since you are buying components and only assembling them, the raw material costs did not vary depending on where you manufactured. Therefore, she seemed to be on the right track in arguing that Pakistan would be the cheaper location. Nevertheless, you dig deeper and find the following data (assume no quality differences, zero transportation costs, etc.):

Toys produced /unit of labor

Plastic - Pakistan 3 , USA 6

Electric - Pakistan 2, USA 6

a) What are the opportunity costs of producing each of these goods in each country? (1 point)

b) Based ONLY on the data in the table (i.e. ignoring wage rates), would you move ALL production to Pakistan? If so, why? If not, would you move one product to Pakistan? If so, which one, and why? (1 point)

c) Now include the wage rates in your analysis. What would you recommend to the CEO? If you recommended moving any production to Pakistan, justify your decision. If you recommend not moving any production to Pakistan, justify your decision to the CEO by determining (3 points)

i. The wage level at which it would be optimal to move some production to Pakistan

ii. The wage level at which it would be optimal to move all production to

d) What are the limits to the exchange rate at which it makes sense to produce at least something in both countries? (3 points)

Answer 1