Question

This exercise analyses the effects of immigration in a Heckscher– Ohlin model. The island of Kauai in the Pacific Ocean produces two goods using skilled and unskilled labor. Naturally, Kauai can be considered a small economy and a wise government has led to complete trade liberalisation.

(a) In the initial situation in which trade in final goods is free, Kauai produces both goods. The technology is characterized by the absence of factor intensity reversals. How can you determine the factor prices prevailing in the country?

(b) The country has now received a limited inflow of unskilled immigrants. The island of Kauai continues to produce both goods in the free trade equilibrium. What are the effects of immigration on the return to domestic workers?

(c) Assume now instead that the immigration flows are substantial, so that Kauai ends up specializing in the production of the goods that is intensive in the use of unskilled labor. What are the effects on domestic worker’s income?

Answer 1

The Heckscher-Ohlin model states that other assumptions being given or met, a particular country will like to produce or will have a comparatively greater advantage in the production of that good in which the comparatively or relatively abundant factor is exclusively or intensively absorbed or utilized. This utilization of the comparatively more factor of production results in a larger economic benefit for the country.

(a) Under the given situation, where Kauai has a trade free on the final product of goods, and the factor intensive reversals are non-existence with regard to the technological sector in the country, Kauai would be interested in the production of both the goods at a similar rate and proportion. The factor prices, which means, at what prices of production a particular good need to be produced in order to attain a defined or assumed maximum profit, will in this case depend upon the demand of the consumers. Given that the trade for the goods is free at the final stage, i.e. the final product, the real factor which would determine the factor prices would be the demand for the particular goods in the economy. Although, Kauai may be experiencing a situation where , it is able to produce both the goods at the similar rate due to the intensive factors of production not favoring any particular product, the producers would want to examine the market to see , the status of the demand of the goods in the economy. If there is more demand for one particular good, it means that the production of tat good with an increased factor prices is more beneficial to the economy. However, if the demand for both the goods are similar in nature, in that case, the Kauai market would take the shape of an equilibrium profit for the firms, and they would not be able to make extra normal profit.

(b) Kauai has an economy that has been able to produce both the goods at a similar rate and quantity due to a static and non-proliferating factors of production. One among these important factors of production is the labor supply. The availability of labor in the production of any good largely impact the final output of the product. It also directly impacts the total average wage earned by the laborers, where it can directly reduce the wages for some and increase the wages for others, or more often, reduce the average wage of the laborers. Under the given situation, where there is a limited influx of immigrants which are not skilled labors, the economy would now have comparatively more labor than the optimal stage earlier, although they are not skilled. In such a situation, the firms would want to utilize the unskilled labor in some of the categories of the work, where unskilled labor can be allocated, and the skilled labor can be moved to the categories where they can be better utilized. All these steps would bring in these limited number of laborers in to the production factor framework. This will lead to the firms, now, wanting to pay lesser wage to the already existing laborers or workers, as they now are having to distribute the total available wages to more workers. However, since the inflow of the immigrants if not alarming, the economy would still continue producing both the goods, however, the cost of production of the labor intensive good would be lesser and profitable for the firms. The wages of the workers would go down by a small margin.

(c) Under the current situation, where Kauai now has a huge influx of immigrants which are unskilled, the economy would slowly start moving towards a labor-intensive production market. The huge unskilled labor force would push the firms for their production to move towards the goods which are more labor intensive. The Firms would see more profit in the production of these goods, in which more of the unskilled labor can be utilized at a lesser cost of production. This will result in the firms trying to either move the earlier existing skilled labor to the production of other goods , wither in their own firms or asking them to join any other firm which specializes in the production of goods which require skilled labor, or, the skilled labor may be forced out of their job due to the huge competition from the unskilled labor at a much lesser wage rate. This will directly lead to a situation where the skilled and earlier exiting labor are now either out of their job or have moved to the unskilled market or are still working in those firms which specializes in the production of goods which require them dearly. In any of these circumstances, the wage rate of these skilled and pre-existing workers is bound of fall drastically. The market would slowly move toward and become and labor-intensive market.