LESSON 3

• Specific Factors Model developed by Paul Samuelson and Ronald Jones
• Assumes an economy that produces two goods and can allocate its labor supply between the two sectors
• Allows for the existence of factors of production besides labor
• Manufacturers are produced using capital and labor (but not land)
• Food is produced using land and labor (but not capital)
• Diminishing returns in production: each successive person-hour increases output by less than the previous one
• Assumptions of the Specific Factors Model:

  • Two commodities X and Y
  • Two countries A and B
  • Land, labor, and capital are the three factors
  • Conditions of perfect competition in commodity and factor markets
  • Greater use of labor in country B than in country A
  • Identical production techniques in the two countries
  • Identical tastes and preferences of consumers in the two countries
• Trade and Relative Prices:

  • Integrated world economy production of manufactures and food is the sum of national outputs of the two goods
  • World's relative supply of manufactures lies between the relative supplies of the two countries
  • World relative price of manufactures lies between the national pre-trade prices
• Income Distribution and the Gains from Trade:

  • Trade is a source of potential gain for everyone
  • Consumption in the absence of trade would have to be a point on the production possibility frontier
  • Trading economy can consume more of both goods than in the absence of trade
  • It is possible to give each individual more of both goods, making everyone better off
• The Political Economy of Trade:

  • Optimal Trade Policy: government chooses policies to maximize the welfare of its population
  • Income Distribution and Trade Politics: those who want trade limited are more effective politically than those who want it extended
• A better way to assess the overall gains from trade is to ask: Could those who gain from trade compensate those who lose, and still be better off themselves?