Question

Suppose there are two countries, the U.S. and Mexico. Before immigration, wages are higher in the U.S. Both countries produce the manufactured good using labor and capital, and the agricultural good using labor and land (i.e. labor is mobile, but land and capital are specific factors). Assume that there is no change in the prices of the manufactured and agricultural goods, and there is no international trade in these goods, either. (4 points each, 12 points total)

Hint: you do NOT need to show the gains from immigration in the graphs below.

(1) Draw a diagram showing the labor demand curves of the U.S. and Mexico, and the equilibria for these two countries before immigration.

(2) Label the equilibrium with free immigration, and the size of the immigration flow in your diagram in (1).

(3) Suppose Mexico was hit by a currency crisis and went into a deep economic recession. Use the diagram in (1) to show the effect of the Peso crisis on the size of the immigration flow.

Answer 1

A few months later, things turned bad for Old McDonald. In December 1998, the

European Union increased its tari®s on imported tomato pulp, implying that the net

price received by American exporters is now only $5/t. It is not expected that this

price will change in the future. One accountant consulting for Old McDonald stated

that as margins have declined drastically the farmer had better sell the machine right

away and go back to producing unprocessed tomato. Old McDonald is trying to

decide whether to take this consultant's advice.

(b) What would you advise Old McDonald to do?

(c) Would your advice change if the price of unprocessed tomato were expected

to be $0.50/t higher than described above? Explain why or why not.

Solution:

(a) The user cost of capital corresponding to the machine is given by 8% times $200,000 plus

(200; 000 ¡ 50; 000), or simply $166,000. Divided by 100,000t this gives $1.66/t. Adding

labor costs of $2.2/t, this gives a total of $3.86/t, the average cost. Marginal cost is $2.2/t

up to 100,000t/year, in¯nity thereafter. The pro¯t margin is therefore $6-$2.2=$3.8/t (up

to 100,000t).

(b) We are considering the option of continuing to produce tomato pulp versus the option of

producing unprocessed tomato. There are two opportunity costs that need to be accounted

for. First, by selling tomato pulp the farmer is foregoing the chance of selling unprocessed

tomato. This opportunity cost amounts to the the margin on unprocessed tomato, or $2.1/t.

The second opportunity cost is that of the machine | the user cost of capital. Since the

machine is now worth only $50,000 and will last for one more year, the user cost of capital

is given by 50,000 plus 8% times 50,000 plus, or $54,000, which corresponds to $.54/t. The

average economic pro¯t, that is, including all imputed costs is, $5 (price) - 2.2 (labor) - .54

(cost of capital) - 2.1 (margin on unprocessed tomato) = $.16. Since this is positive, the

¯rm should continue operating the machine and sell tomato pulp.

(c) By a calculation analogous to the one above, we conclude that the farmer is better o® by

switching to unprocessed tomato.

2.8¤ Las-O-Vision is the sole producer of holographic TVs, 3DTVs. The daily

demand for 3DTVs is D(p) = 10200 ¡100p. The cost of producing q 3DTVs per day

is q2=2 (note this implies that MC = q).

(a) What is Las-O-Vision's total revenue schedule?

(b) What is Las-O-Vision's marginal revenue schedule?

(c) What is the pro¯t-maximizing number of 3DTVs for Las-O-Vision to produce

each day? What price does Las-O-Vision charge per 3DTV? What is its daily pro¯t?