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# reducing protection will have on factor prices

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Possible models: Strategic trade theory, Krugman model, Rybczynski theory, Stolper-samuelson and Heckscher-Ohlin model and the optimal tarriff theory.

a. explain some models that predict the effect that reducing protection (Tariffs) will have on factor prices (Labour and capital)? Use these models to analyse the effect that reducing protection would have had on factor prices in Australia? How plausible are these models?

b. Under what circumstances can reducing protection make a country as a whole worse off? Could such models have any relevance to the Australia?

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Effect that reducing protection will have on factor prices

Possible models: Strategic trade theory, Krugman model, Rybczynski theory, Stolper-samuelson and Heckscher-Ohlin model and the optimal tarriff theory.

a. explain some models that predict the effect that reducing protection (Tariffs) will have on factor prices (Labour and capital)? Use these models to analyse the effect that reducing protection would have had on factor prices in Australia? How plausible are these models?

First if we consider Krugman's model. L = a + b*Q. It says that the amount of labor required to produce amount of input (Q( depends on b and constant a (fixed cost). In other works doubling the inputs more than double the output. The model assumes increasing internal economies of scale. According to this model if protection were reduced, the cost per unit gets reduced and so the demand for labor increases. This is bound to increase the price of labor. The model makes the assumption that there is only one factor of production namely labor.

Similarly let us consider the Rybczynski theory. From the factor price equalization results it studies the impact of an increase in an input say labor at constant prices for final goods. If the prices of final goods do not change, then the rewards to factors of production do not change. This means that the capital-intensity with which the two goods are produced or the capital-labor ratio do not change. If good X uses capital relatively intensively then K(x)/L(x) > K(y)/L(y); In other words, it is the labor intensities for goods X and good Y that determines the allocation of capital and labor. If protection is lifted and more labor becomes available (manufacturing gets outsourced), if the goods prices do not change the K/L intensity does not change. On the other hand if the prices are affected the K/L intensity changes and this will have an effect on factor ...

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## Discuss the small-country case of tariffs, using partial equilibrium analysis.

1. Discuss the small-country case of tariffs, using partial equilibrium analysis.

2. Suppose the free trade market price of a car is \$10,000. It contains \$5000 worth of steel. The importing country imposes 25% tariff on car imports.

a. Calculate the effective rate of protection if there is no duty on steel imports.

b. Calculate the effective rate of protection if the importing country imposes a 20% tariff on steel imports.

c. Suppose it also takes \$2000 worth of copper (besides \$5000 worth of steel) to produce a car. Calculate the effective rate of protection if there is no import tariff on the imports of either steel or copper.

d. Suppose there is import duty of 20% and 15% on imports of steel and copper, respectively. Calculate the effective tariff rate.

3. Explain the difference between the price and the physical definitions of factor abundance. When could they give conflicting answers about which factor is the abundant factor?

4. Ignoring the mathematics, explain the operation of the Krugman model in economic terms and indicate its principal lessons.

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