Chapter 4: Specific Factors and Income Distribution

What is the specific factors model?

A model with three production factors: labor (mobile), capital and land (sector-specific)

What are the key assumptions of the model?

Two goods (e.g., clothing and food)

Capital and land are specific to each good

Labor is mobile

Perfect competition

Why is the PPF in this model bowed out?

Because of diminishing marginal returns to labor in each sector.

How are wages determined?

Firms hire labor until the value of the marginal product of labor equals the wage

What happens when the price of one good increases (e.g., clothing)?

Labor shifts to that sector

Wages rise

Capital owners (in clothing) gain

Landowners (in food) lose

Who gains and loses from trade in this model?

Export sector owners gain

Import sector owners lose

Mobile labor is affected ambiguously

What is the effect of trade on relative prices?

Trade aligns domestic prices with world prices, changing output mix.

How does trade influence income distribution?

It benefits the factor specific to the export sector and harms the factor specific to the import sector.

How can trade increase overall welfare despite some losing?

Winners can, in theory, compensate losers, leading to a net welfare gain.

What policy conclusion is drawn from this model?

Rather than limiting trade, governments should support adjustment for affected groups.

 What is the role of the production possibility frontier in this model?

It shows the trade-off in outputs when reallocating labor between sectors.