Question

Consider a simplified offshoring model with two firms, Techland in home country and Prodland in foreign country, and two activities, Components and R&D. Components is low-skilled labor intensive whereas R&D is high-skilled labor-intensive. The final good produced is Mphone. The costs of capital and trade are uniform across production activities. The wage structure in Techland (T) and Prodland (P) for low- skilled labor (L) and high-skilled labor (H) is as follows: Home: WTL = 30,000, WTH = 90,000 and Prodland: WPL = 1,000, WPH = 5,000 A. Which country has the higher relative wage of low-skilled labor? (1 points) B. Suppose the two countries engage in trade. Which activity will Techland offshore, and why? (1 points) C. By opening to trade, Techland finds that it can import the components more cheaply than it could produce on its own (due to lower world-relative price of components). Draw a diagram to illustrate the gains to Techland from offshoring. (1.5 points) D. Now suppose Prodland engages in international trade. Illustrate the Prodland's resource allocation and production of final goods when it faces the new relative price of components. (1.5 points)

Answer 1

A. Relative wage of low-skilled labor in Techland is given by:

WTL/WTH = 30,000/90,000= 0.333

Relative wage of low-skilled labor in Portland is given by:

WPL/WPH = 1,000/5,000= 0.2

So, Techland has the higher relative wage of low skilled labor

B. Techland should take the activity -R&D since we found out that the relative wage of low skilled labor is higher in Techland this means that the Techland as to pay more wages to lo skilled labors than the high skilled labors so it is profitable for the Techland to produce high skilled labor products.