Specific Factors Model


 1. Specific Factors Model

 Who?

Jacob Viner first examined the specific factors model, which is a variant of the Ricardian model.

It was further developed by Paul Samuelson and Ronald Jones. It is also called the Ricardo-Viner model. Michael Mussa (1974) developed the graphical approach to illustrate the main results of this model. In contrast to the Ricardian model, this model includes factors other than labor.

Mobile vs Specific Factors

 Thus, there are two types of factors. Labor is the mobile factor that can move between the two sectors. Each of the other two factors is assumed to be specific to a particular industry. That is, the quantity of each specific factor is fixed and cannot move to the other industry. Specific factors cannot move between industries.

Examples of specific factors: climates, soil, skilled workers.

 Assumptions:

2 goods x 3 factors

K is used in industry 1 only.

T is used in industry 2 only.

Labor is mobile. 

The economy produces two goods using two factors of production, capital and labor in a perfectly competitive market. Capital is assumed to be specific to each industry, and is immobile between industries. In the two good model, there are two specific factors, K and T.

In this sense, Jones calls it a 2-good, 3-factor model. (K = Kapital, which is capital in German, T = Terra in Latin, meaning land or earth. We do not use L to denote land because it is reserved for labor, and the lower case l looks like "one." It is best to avoid confusing symbols.)

 Example

 Finland produces ocean cruisers and leather products such as reindeer fur, mink and fox coats.

Lapland, the nothern part of Finland, is sparsely inhabited by mostly Indians who hunt these wild animals. This cold climate or forest is a factor specific in the leather goods industry.

In the urban areas Finns are also engaged in cruise ship building and Finland exports cruisers to European countries. In addition to well educated workers, the ship building industry requires a large amount of capital, which is specific to that industry in that it cannot be used in the leather goods industry. Finnish workers are mobile between the two industries.

Palio in Piazza del Campo (Siena, Italy 2000). Horse trainers are specific to the horse industry. Jockeys ride horses without saddles.

Organized by ten contrade (districts) in 1590 when bullfighting was outlawed. (Palio di Provenzano, July 2, and Palio dell'Assunta, August 16.)

 Specific Factors model vs Heckscher-Ohlin In a Heckscher-Ohlin model to be studied shortly, both factors, capital and labor, are assumed to be mobile. Recall that in production decisions, some factors are fixed (and hence specific) in the short run, but all factors are variable inputs in the long run. Hence, the HO model is a long-run model, whereas the specific factors model is a short run model in which capital and land inputs are fixed but labor is a variable input in production.
 Production y1 = F(K,L1)

y2 = G(T,L2)

In contrast to the Ricardian model, labor is the mobile factor between the two industries.

Resource constraint:

L1 + L2 = L

π1 = p1y1 - wL1 - rK

Consider a change in the amount of labor employed, ΔL1.

Δπ1 = p1Δy1 - wΔL1 = 0 for a maximum profit (The profit function must reach a peak or a plateau so that a change in profit is zero)

Divide both sides by ΔL1.

p1MPL1 = w

Alternatively,

p1 = w/MPL1 = MC1 (For instance, if the marginal worker produced 2 automobiles and got paid $60,000, marginal cost of the automobile is $30,000).

p2 = p2y2 - wL2 - sT (s = land rental, sT = landlords' income)

p2MPL2 = w.

p1MPL1 = p2MPL2

p1/p2 = MRT = MC1/MC2

  In competitive markets, each factor receives its marginal product. For instance, a worker's wage is the value of his marginal product. 
                 

2. Main Results

 (1) No specialization

Diminishing Returns: Marginal product of labor (or any other input) declines as more is employed. ⇒ PPF is concave to the origin!

Unlike in the Ricardian model, labor is shared between the two industries. Thus, the specific factors model explains why a country produces a product and also imports it. For instance, the US produces but also imports oil from the Middle East.

(2) No wage equalization

Choose any price. For instance, in industry 2, we have
p2MPL2 = w,

p*2MP*L2 = w*.

Thus, w ≠ w*.

If labor productivities are different in the two countries (due to weather, capital or infrastructure), free trade will not equalize wage rates. However, due to diminishing marginal returns, marginal product of labor decreases with employment. In general, MPLi is not equal to MP*Li in any industry. Free trade equalizes output prices, but not wages.

Allocation of labor
If labor is mobile between the two industries, one wage prevails in each country. Both industries pay the same wage in each country, but w ≠w*.
 Price effect

 How does a change in the output price affect income distribution?
An increase in the price of the exportable increases wage.

An increase in the price of the exportable increases rent.


More generally,

(3) Which factor benefits from trade

An increase in the price of a good increases the rent of the factor specific to that industry.

For instance, international trade raises the price of the exportable good (foodstuff, such as corn and soybean), which in turn raises the price of the factor stuck in that industry such as land. That is, trade raises land value in the Midwest.

The US government now endeavors to achieve energy independence, i.e., independence from imported oil. Billions of dollars are now being invested to develop alternative source of energy such as ethanal from corn or switchgrass. This increase in the price of ethanol should increase the land value in the Midwest, because it is a fixed factor there.

(4) Main Result

(Effect of Free Trade)

The specific factor in the export sector benefits from free trade.
because a movement toward free trade (FT) increases the price of the exportable (p1). Thus, free trade increases the return to the factor (K) specific to the export sector.

Example: Rising food prices raise the price of land (a necessary and specific factor in agriculture) and land owners benefit from free trade.

Water scarcity in Africa and Asia ⇒ (for about 1.7 billion people) Rising water price ⇒ rising land price during the next few decades!

 

 An increase in the price of the exportable increases its output. Note that PPF is concave to the origin, unlike that in the Ricardian model.

The Silkroad during
Tang period (618-907 AD)

Silk was invented by the Liangzhu people who settled down in Liangzhu (near Shanghai now) about 3000 BC. The Liangzhu people was trading jade artifacts during the Neolithic period (3300-2200 BC) even before their first dynasty, Xia. In the "Arabian Nights," the story of Aladdin, a lazy boy in China, indicates that Arabia was an intervening region on the silk road and Arabia connected China and Africa. Gold, amber, and ivory were prized in China and imported from Africa. Aladdin itself is either Persian or Arabic name, meaning "faithful." The intervening regions also joined the trade on the silk road.