Question

Consider an economy that produces manufacturing goods and R&D services with two types of high skilled workers (Engineers and Scientists) and one type of low-skilled workers. The production technology for R&D services is high-skill-labor intensive, while manufacturing is low-skill intensive. In the medium-run, engineers are stuck in the manufacturing sector and Scientists are stuck in the R&D but the low-skilled workers can move between the two sectors. In the long-run, however, all factors are mobile. Suppose that this economy opens up to free trade and experiences an increase in the relative price of R&D services. Answer the following questions using appropriate theorems and concepts.

a. Is this country abundant in high-skilled or low-skilled labor?

b. What will happen to the size of each industry in the medium and long run?

c. What is the welfare impact of trade liberalization on each factor of production in the medium run?

d. What is the welfare impact of trade liberalization on each factor of production in the long run?

Answer 1

a. Is this country abundant in high-skilled or low-skilled labor?

Note that this economy when engages in free trade finds that there is an increase in the relative price of R&D services. We are given that R&D services is high-skill-labor intensive. Hence we expect that country is able to increase the income of its high-skill-labor. Based on the results of H-O model, we believe that country is abundant in high-skilled labor.

b. What will happen to the size of each industry in the medium and long run?

In the medium run, attracted by higher wages, labor will move from other industries to this industry. Hence R&D industry will expand and manufacturing will fall.

c. What is the welfare impact of trade liberalization on each factor of production in the medium run?

In the medium-run, engineers are stuck in the manufacturing sector. Hence they cannot move to other sectors so when R&D expands and manufacturing contracts, engineers experience fall in their income and welfare. And Scientists are stuck in the R&D so their income increases along with their welfare. Since manufacturing is low-skill intensive, hence the low-skilled workers will also experience a fall in their relative wages and welfare.

d. What is the welfare impact of trade liberalization on each factor of production in the long run?

In the long run all factors are movable so both engineers and Scientists would move towards R&D. Increased supply of workers may erode the increase in relatives wages in the medium run so that in the long run wage rates are equalized in both the industry. Low skilled workers will experience a higher wage when manufacturing experience reduction in labor supply and wage rate is increased.