Question

Think about an extension of the specific-factors model, in which, in addition to their wage, labour also earns some part of the rental on specific factor in their industry, i.e., farmers who own their own land and manufacturing workers who salary includes a profit-based bonus. Discuss how this extension affects the conclusion of the model.

*This is not about the regular ambiguous nature of the mobile factor. The question is asking if labour was earning income from capital as well in the specific-factors model, how would this change the already known conclusion of the model. So this is a different scenario

Answer 1

The Specific Factor Model

The specific factor (SF) model was originally discussed by Jacob Viner and it is a variant of the Ricardian model. Hence the model is sometimes referred to as the Ricardo-Viner model. The model was later developed and formalized mathematically by Ronald Jones (1971) and Michael Mussa (1974). Jones referred to it as the 2 good-3 factor model. Mussa developed a simple graphical depiction of the equilibrium which can be used to portray some of the model results. It is this view that is presented in most textbooks.

The model's name refers to its distinguishing feature; that one factor of production is assumed to be "specific" to a particular industry. A specific factor is one which is stuck in an industry or is immobile between industries in response to changes in market conditions. A factor may be immobile between industries for a number of reasons. Some factors may be specifically designed (in the case of capital) or specifically trained (in the case of labor) for use in a particular production process. In these cases it may be impossible, or at least difficult or costly, to move these factors across industries. See Sections 70-1 and 70-2 for more detailed reasons for factor immobility.

Basic Assumptions

The specific factor model assumes that an economy produces two goods using two factors of production, capital and labor, in a perfectly competitive market. One of the two factors of production, typically capital, is assumed to be specific to a particular industry. That is, it is completely immobile. The second factor, labor, is assumed to be freely and costlessly mobile between the two industries. Because capital is immobile, one could assume that the capital in the two industries are different, or differentiated, and thus are not substitutable in production. Under this interpretation, it makes sense to imagine that there are really three factors of production: labor, specific capital in industry one, and specific capital in industry two.

These assumptions place the specific factor model squarely between an immobile factor model and the Heckscher-Ohlin model. In an immobile factor model, all of the factors of production are specific to an industry and cannot be moved. In a Heckscher-Ohlin model, both factors are assumed to be freely mobile; that is, neither factor is specific to an industry. Since the mobility of factors in response to any economic change is likely to rise over time, we can interpret the immobile factor model results as short-run effects, the specific factor model results as medium-run effects and the Heckscher-Ohlin model results as long-run effects.

Extension effects

1) the real return to capital in the export industry will rise with respect to purchases of both exports and imports2) the real return to capital in the import-competing industry will fall with respect to purchases of both exports and imports,3) the real wage to workers in both industries will rise with respect to purchases of the import good and will fall with respect to purchases of the export good.

This result means that when a factor of production, like capital, is immobile between industries, a movement to free trade will cause a redistribution of income. Some individuals, owners of capital in the export industry, will benefit from free trade. Other individuals, owners of capital in the import-competing industries, will lose from free trade. Workers, who are freely mobile between industries may gain or may lose since the real wage in terms of exports rises while the real wage in terms of imports falls.Notice that the clear winners and losers in this model are distinguishable by industry. As in the immobile factor model, the factor specific to the export industry benefits while the factor specific to the import-competing industry loses.