Question

II. Outsourcing

1. Consider an offshoring model in which Home’s skilled labor has a higher relative wage than Foreign’s skilled labor, and in which the costs of capital and trade are uniform across production activities.

a. Will Home’s offshore production activities be high or low on the value chain for a given product? That is, will Home offshore production activities that are skilled and labor intensive, or low-skilled and labor- intensive? Explain.

b. Suppose that Home uniformly increases its tariff level, effectively increasing the cost of importing all goods and services from abroad. How does this affect the slicing of the value chain?

c. Draw relative labor supply and demand diagrams for Home and Foreign showing the effect of this change. What happens to the relative wage in each country?

Answer 1

a. It is a simple example of trade off. Normally there are two types of goods that are produced in a particular country. One is capital intensive goods and another is labour intensive goods. The situation describes that at the home countries labour charges is more than the foreign countries. So in trade off it will be optimal solution to produce more capital intensive goods so that the overall production cost can be minimised. At the same time other countries will produce more labour intensive goods. And hence by trading between both the countries, both countries will be in favourable stage.

For example if country A has the absolute advantage of producing car because of of its lower capital cost and the country B has the absolute advantage of producing wheat because of lower labour cost then by trading both the countries will be in win win stage.

b. If there is a imposition of tariff then the cost of import will be increased. Now keeping this situation if the cost of imported goods becomes more costly then the goods produced in home country then the country will decrease the imports but if bodha cost equal then it is up to the countries decision whether to produce more goods in home country or to import.

c. By producing more capital intensive goods the demand of labour will be decreased in home country and the wages well also be decreased. Similarly by producing more labour intensive goods the demand of labour in foreign countries will raise and the wages of labour will be increased.