Immigration Effect on American Jobs

In the past couple of classes we have discussed immigration and the effect that it has on American wages, and job opportunities.  Though it is often seen as a bad thing for Americans and their wages,  economic research proves that in the long run, as we discussed, that is not necessarily the case.  Through the article posted below, I have come to a better understanding of why this is true.


http://www.americanprogress.org/issues/immigration/news/2013/08/29/73203/immigration-helps-american-workers-wages-and-job-opportunities/


The point that I found most interesting in this article, is the author's idea about manufacturing.  When immigrants come into the United States to work, labor in the manufacturing sector is going to increase.  Off-shore manufacturing will also decrease, and these two factors will benefit workers in the United States in the manufacturing sector.  The demand (over the long-term) will rise for manufactured goods within the United States, thus increasing the number of manufacturing jobs domestically.  Wages are then going to increase because of the increased demand for the manufactured goods produced domestically.  The reason that a lot of American view this as a negative, is that this takes a lot of time to play out.  Americans see immigrants coming into the country and working in their place.  However, what they do not realize is that the immigration is causing an increase in the American terms of trade because of the increased output that has come with the rise in labor.  The rise in labor also helps compliment the existing capital domestically.  With the influx of labor and both high and low-skilled immigrants there is nothing but positive implications for wages in the long run.

Office Hours 10/23

With apologies, I will have to cancel my office hours for today, Thursday, October 23, since I am home with a kid from school. I will hold my normal office hours from 8:30-9:45 Friday in the Beehive, and will also be available after about 1:30 in my office.

Problem Set 2 Solutions

For those who have not already seen it after I posted it yesterday, the Problem Set 2 Solutions are posted in the Class Files section of the website.
(Comments not for credit.)

Technology Improves U.S. Terms of Trade and More

For many a decade the OPEC countries have dominated the exportation of oil and that fact remains true today. However, in recent times improvements to technology such as hydraulic-fracking have allowed the United States the opportunity to extract record amounts of oil domestically and export it in similar fashion; this increase in exportation positively affects the terms of trade for the United States. Yet, this is not the basis for Thomas Friedman's NY Times article A Pump of War?; rather, Friedman focuses on the "invisible"global oil war which pits the United States and Saudi Arabia against Russian and Iran and how the new technology and by extension improved terms of trade for the U.S. allow for a victory in foreign policy without putting boots on the ground.

With recent actions taken by the Russian government, it has been in the interest of the United States and other world powers to stop President Putin, and to date they have tried the method of economic sanctions which have done little to stop the Russian as well as Iranian oppression. In his article, Friedman suggests that the new technology in extracting oil allows the United States to "pump them to death — bankrupt them by bringing down the price of oil to levels below what both Moscow and Tehran need to finance their budgets." This occurs because the amount of oil that the United States has now flooded the market with in combination to the status quo output of oil from Saudi Arabia, has dropped the price of oil for weeks from the long stretch of barrels of crude oil costing between $105-$110 to now resting prices of $88. This forces Moscow and Tehran to sell their batches of oil at a lower price eventually leaving the budgets for their respective governments in the red as the exportation of oil accounts for well over 50% of GDP for both nations. This same process was used to dismantle the U.S.S.R by the Saudi government in 1985 and is hoped to work again today in age to stop Putin and Khamenei in their tracks.

Not only does improved technology in oil extraction improve the United States' terms of trade, but it also helps gain victories in foreign policy without putting boots on the ground.

Oil Prices Dropping and the Impacts on Trade

If you have been to or even driven by a gas station recently you probably have noticed that gas prices have dropped considerably. A lot of gas stations in the area are selling gas for under three dollars per gallon which is pretty unheard of. The recent drop in gas prices has been due to the recent dips in oil prices. Over the past month oil prices have dropped by almost 20 dollars per barrel. Oil is one of the more important resources in the modern world and the price of oil dropping can have effect a lot of things. One of those would be trade.
But how exactly would these lower oil prices impact trade. The first obvious impact would be on the counties that export the most oil like Saudi Arabia, other middle east countries and Russia. The terms of trade in these counties would most certainly drop because the price of their main export is decreasing while the price of their imports is likely staying the same. At the same time the countries that import the most oil like the United States and China would see their terms of trade increase because the price of their imports is dropping while exports remain constant.
Linked here is and article that goes more in depth on the effect of low oil prices on oil exporting countries. This article talks more about the historical impact on counties that export oil when oil prices are low.
Another impact on trade we might see would be that with oil prices so low it is a lot cheaper for companies to export their goods. This could make exports and imports cheaper for countries because the price of shipping the goods will be lower. The change in terms of trade would just depend on which factor changes more.
Overall I believe the recent drop in oil prices will benefit the United States greatly and not just because gas is cheaper. Unfortunately for counties like Saudi Arabia they will be worse of for now but I'm sure oil prices will bounce back.

What immigrants do to the economy of US?

Nowadays, workers form developing countries immigrate to wealthier countries to seek for higher salary and better life when they are able to. In the US, immigration policy is debated in Congress nearly every year. Indeed, immigration ranks among the top issues in surveys of voters just after jobs and health care. It is estimated that there are about 12 million illegal immigrants in the US, many of them are from Mexico.Do Illegal Immigrants Actually Hurt the U.S. Economy?

As we have briefly discussed in the class,immigrants makes the  economy (GDP) larger. However, by itself a larger economy is not a benefit to native-born Americans.With the immigrants flowing into US,though the immigrants themselves benefit,similarly skilled native-born workers are faced with a choice of either accepting lower pay or not working in the field at all. According to the article, Labor economists concluded that undocumented workers have lowered the wages of U.S. adults without a high-school diploma — 25 million of them — by anywhere between 0.4 to 7.4 percent. Those people tend to be the biggest losers from immigration since the least educated and poorest Americans are the most likely to be in competition with immigrants.On the other hand, the owner of capital can benefit from hiring workers at a relatively lower wage,which means the rental of capital increases.

The article points out another important point of why immigrants make the economy better: "Giovanni Peri, an economist at the University of California,concluded that undocumented workers do not compete with skilled laborers — instead, they complement them.Economies, as Adam Smith argued in “Wealth of Nations,” work best when workers become specialized and divide up tasks among themselves.In states with more undocumented immigrants, Peri said, skilled workers made more money and worked more hours; the economy’s productivity grew.The owner of capital no longer had to pay a highly skilled worker to perform basic tasks."

Another benefit of immigrant that mentioned by the article is the fiscal impact — taxes paid by immigrants minus the costs they create for government.Undocumented workers contribute about $15 billion a year to Social Security through payroll taxes while only take out $1 billion (because very few undocumented workers are eligible to receive benefits). Over the years, undocumented workers have contributed up to $300 billion, or nearly 10 percent, of the $2.7 trillion Social Security Trust Fund.

Undeniable,immigrants benefit the overall economy.They bring diffuse and hard-to-see benefits to average Americans while imposing more tangible costs on a few. Whether or not we should do something to restrict immigrants seems more like a political question than a economic one.

Further reading:The Fiscal and Economic Impact of Immigration on the United States

Heckscher-Ohlin Model to Debunk Wage Inequality's Popular Theory

This article by Arvind Panagariya discusses the Heckscher-Ohlin model and how it can be used to describe the reasoning behind the increase in wage inequality between skilled and unskilled workers in recent years.  Between the late 70’s and early 90’s the ratio of skilled-to-unskilled wages rose almost 30% in the United States. At this time, trade between developed and developing countries rapidly expanded. Panagariya explores the causes for this gap in this article.

The H-O model is suitable for this analysis because it allows us to focus solely on the income distribution effects without having to take into account differences in technology as does the Ricardian model. Panagariya begins the article by thoroughly explaining the Heckscher-Ohlin model, just as we have in class. The primary conclusion drawn from the H-O model is that each country open to free trade will export the goods that use its abundant factor more intensively and import the goods that use its scarce factor more intensively. After many calculations and graphs we can further conclude that the relative and real factor returns, specifically the wage-rental rate, of countries open to free trade eventually equalize. Therefore, we can discredit the theory that the wage inequality is caused by trade with developing countries.

Panagariya draws on further research to support his opposition. He cites Krugman (1995) to have stated that the 2% of total expenditure occupied by imports from developing countries is too small to explain such a large increase in wage inequality. Finally, Panagariya declares his theory for the increased wage inequality to have been caused by a shift in technology in favor of skilled labor. Technological advances have been shown to shift demand to support skilled labor and an increase in wages while leaving unskilled labor to suffer. The Heckscher-Ohlin model has offered a viable explanation as to why trade is simply not to blame for the increase in wage inequality.


*I found this article in the SAU database so if you open it using SAU's server it should work but if you're off campus you'll have to login to access the online database. You can do this through the library's webpage using the "Find Articles" tab under "Resources."

Extension of the Heckscher-Ohlin Model

The Heckscher-Ohlin model is centered around the idea that relative factor abundance and intensity is what determines the pattern of trade between countries.  As we found in the example of Leontief’s Paradox, this is not always the case.  This paradox has brought attention to economists to create extended versions of the Heckscher-Ohlin model that account for real world situations by assessing more than two goods or factors.  The paper linked to this post does this by examining one of the extended H-O models, created by Romalis, and building on it by using trade data between the U.S. and China from 2000 and 2005.

China is best for comparison to the U.S. because of its large portion of unskilled labor compared to America’s that will manifest in the data.  The author analyzes the trade data for factor intensities by running regressions to see if there is a negative correlation between the factor intensities and the amount of goods China imports from these factors of production.  The finding does hold true to the H-O model prediction that as factor intensity rises, the less China will import in that industry from the U.S.  This is what we would expect in any country based on the H-O model since countries import the good in the sector that they are scarce in that effective factor.

The reason I chose this working paper is to expand on the simplistic idea of the H-O model we learned in class.  I especially like how the use of empirical data solidifies the validity of the H-O model as opposed to the Leontief paradox counterexample.  However, critics of Leontief’s paradox argue that his findings are skewed because of the failure to include more than just labor and capital as well as the distinction of skilled and unskilled labor.  This paper includes both of these, which is why the results were on point with the H-O model.  Although the point of this paper was not to fire shots at Leontief, it does make a valid point of using properly thought out data to test and extend the validity of the ideas in the Heckscher-Ohlin model.

India Plans Committee to Ease Customs Norms for Boosting International Trade

India has initiated measures to reform customs procedures to speed up international trade.  The Indian government has set up a national committee on trade facilitation that will suggest and implement measurers to ensure seamless movement of cargo by addressing constraints like high transaction costs and poor infrastructure. There will be a 7 or 8 department national committee on trade that will look after all aspects of trade facilitation. India is all for trade facilitation and are working towards it as quickly and efficiently as possible. On July 31 India actually vetoed the trade facilitation agreement at the World Trade Organization, which sought to speed up global trade by reforming customs procedures, arguing there should be a parallel deal on food security. The goal of the trade facilitation requires all departments to be harmonized. The WTO trade facilitation pact was signed in December of 2013 and legally binds all 159 member-countries to standardize customs rules for faster more efficient movement of cross border cargo. This is in hopes to cut transaction cost for exporters. They are working towards ratifying the WTO TFA and need to make legal amendments, but are prepared to do so. During his US visit, Prime Minister Narendra Modi told Barack Obama that trade facilitation was important for India and it expected the US' support in addressing India's concerns over public stockholding for food security. I feel that this is a great thing for world trade. At a population of roughly 1,260,740,000 people, 17.5% of the world population, and an increase in effectiveness and efficiency in international trade this will definitely benefit all countries. India may not be the biggest contributor to the international economy in today’s world, but due to these positive changes they will likely see their contributions to the international economy steadily increase over time.

http://economictimes.indiatimes.com/news/economy/foreign-trade/india-plans-committee-to-ease-customs-norms-for-boosting-international-trade/articleshow/44765924.cms

Supporting Free-trade or Not

Why Are Economists and Non-economists So Far Apart? , this article, in which the author intended to discuss and explain that why there were widely different attitudes towards free-trade between the economists and non-economists, what’s more, suggestions were given by the author simultaneously in order to make efforts to close the gap between two parties.

One of reasons that I am interested in this topic is that I remember that we talked about the impact of politics to trade policy of U.S. in our last class, and the other reason is the rising arguments about free-trade around U.S., which most likely associated with politics that I have focus on for many years.

Based on the democracy in America, any implementations of trade restrictions has to get legislative intervention involved, which leads to a fact that the legislation is often to highlight the visibility of the gains to those who have seized privilege and benefits, which aims to attract votes from those interest group. Otherwise, they sometimes hide the benefits, for the sake of reducing the potential opposition of publicity. Respectively, the media, they understand the significance of the political-favors principle, so a free and enterprising press is needed to be heard by publicity. In this article, the author emphasized the important role of the press today, who are suggested to cover impartial reporting, which are complete, involves exploring who gains, who loses, and the net of gains and losses for the nation as a whole.

To my perspective, a number of argument for free-trade and relatively maintaining certain industries in U.S. are sentimental, partly influenced by exaggerate purposely reports, which mislead and irritated average people who are not familiar with the trade issues. Therefore, I agree with the point mentioned in this article -It is essential to keep two principles -the simultaneity principle and the political-favors principle-in mind when reporting on trade issues.

Shanghai's Free Trade Zone

Shanghai introduced a free trade zone around the city with the expectation that foreign investors would set up warehouses, manufacturing or distribution centers. The end goal is to make Shanghai an international shipping center. To reach this goal there are three guidelines for product movements for the zone: Guideline 1 addresses the relationship between the zone and abroad. By implementing a negative-list approach all sectors are opened for trade except for any excluded by law. This approach allows goods to freely exit and enter China free of customs supervision. Guideline 2 addresses the relationship between the zone and the rest of China. It states that all goods moving into the rest of China will be subject to taxes and regulations. Guideline 3 addresses the zone itself which allows free flow of goods within the zone. The guidelines are straightforward and simple to understand. The difficult part is to know what will happen with financial reform within the zone.

With the trading guidelines Shanghai needs a financial reform to ultimately work. There are 9 components to the financial reform: 1) interest rate liberalization, 2) capital account liberalization, 3) foreign banks can be established, 4) restricted license banks can be established, 5)  foreign invested credit rating companies can be established, 6) particular Chinese banks can engage in offshore business, 7) tax incentives will be given to financial lease businesses, 8) foreign companies are allowed to set up operations within the zone for delivery of goods, and 9) a corporate tax will be implemented for project companies working in overseas equity investment.

With all the above guidelines in place and ready to take effect, Shanghai is waiting for foreign investors to act. So far there are only two new actors in the zone. One is an entrepreneur from Hunan, a province in China, who wants to avoid red tape when getting his business started. The second is Amazon who has plans to build a warehouse in the zone. Even though the zone was only opened 11 days ago the zone has already been considered a failure. Shanghai expected a quicker response from foreign companies even though the JP Morgan article states the development of the zone will be a gradual process.

The zone has a high potential to improve Shanghai’s trading position. As more foreign companies establish a location within the zone it will bring job to domestic workers and increase exports for China while saving the companies money by avoiding import taxes. As the months continue it will be interesting to follow Shanghai’s development and transition into a free trade zone. 

The Implications of Trade Liberalization for Labor Union Behavior

This study analyzes a two country model in which labor unions are present. It found the correlation between (union) wages and the number of firms in the country.


The study shows that unions with fewer firms face a stronger pressure for wage moderation through trade liberalization, and because of this, those firms' cost-competitiveness is reinforced.
It supposes the basic two-country model, with both facing a country-specific monopoly union which maximizes rents and represents 100% of the Labor force. The Unions in each country then take a wage given the wage set by the union foreign to them, while taking into consideration the the firms' labor demand functions. Then each firm chooses it's output taking as given both the output of other firms and the union wage.
The study then assumes that each union maximizes its rents, finding a competitive wage level common in both countries. Finding the Nash-Equilibrium level for wages through a series of functions that quite honestly were above my head (sorry), it obtained the relationship between the number of firms and wages. It then implies that in free trade equilibrium, the country with more firms will have a higher wage-rate.
To this implication there were two propositions: Proposition 1 being that "If the two countries liberalize trade, the union with fewer firms will choose a lower wage level compared to the other country's union."
In the proposition it is explain that increased product market competition implies an inward shift on the demand curve of labor for each union, which in turn works to moderate the union's wage setting behavior. Differences in the number of firms determine the competition, and thus the relative pressure for said wage moderation. Basically, the more firms, the more competition and thus the more pressure for an inward shift. However, the number of domestic firms does not affect wage setting behavior in this instance, because the more firms there are, the higher the aggregate labor demand is, and when the union represents all employees, there is no pressure to reduce wages as all firms are paying the same.
The second proposition was that "In the presence of labor unions, a country with a higher autarky price may be an exporter of the good in a trading equilibrium."
This propositions shows a difference between the standard trade model. In those models, a country with a larger number of firms will have a lower autarky price and become a net exporter due to the pressure on wages described above. In this example with labor unions, liberalization of trade affects unions' wage setting behaviors, that in turn has an affect on trade patterns. Therefore, a country with a smaller number of firms and higher autarky prices becomes a net exporter.

Hopefully this post was as clear as possible, it was definitely very hard to condense this information and "dumb it down", even so much that I had trouble writing it. Regardless, it was an interesting study and I urge everyone to take a look at it.

EDIT: okay the link didn't work. The name of the Study is "Trade Liberalization and Labor Unions" by Toru Kikuchi and J. Atsu Amegashie. Give it a google search!

"Winners and Losers"

     One concept we’ve went over in class recently while studying the Heckscher-Ohlin Model and was touched on by Drew Jacobi in his Free Trade post was the concept of “winners and losers.” I feel like the concept needs to be built upon a little bit more because the country that is considered the “loser” is not always losing necessarily. The Heckscher Ohlin model states that both countries total outputs go up. Just one countries output goes up by a higher level than the others; creating the “winners and losers” scenario.

     The term “distributive effects” refers to the distribution of income gains, losses, or both across individuals in the economy. Distributive effects are the explanation for exactly why some countries lose and some countries win from moving from autarky to free trade. In the Heckscher-Ohlin Model, one country will always be capital abundant and export capital intensive goods whereas the other country will be labor abundant and export labor intensive goods. Both countries will experience a redistribution of income when moving from autarky to free trade. Some individuals will gain from trading goods, while others will lose.  The individuals are where the loss is experienced as Drew explains with the example of the American work force losing.

     Is free trade necessarily bad though because one country has a comparative advantage and causes the “winners and losers” scenario? I think not! I think free trade should be supported because the absolute level of output enjoyed by both the "winner" and "loser" will increase. The only difference is the “winner” will gain more than the “loser. “ Both countries will in the end gain more than they had before in an absolute level.

http://2012books.lardbucket.org/books/policy-and-theory-of-international-trade/s08-12-the-distributive-effects-of-fr.html

ALDS

Up to one comment WILL count for points!

ISIS and Oil

In recent months, the Islamic group known as ISIS has taken over large sections of northern Iraq. Included in that area are oil fields. ISIS has taken over these oil fields and has been trading the crude oil on the black market. Granted, the amount of oil fields that ISIS controls is small compared to the rest of Iraq but the market is believed to be in the area of $2 million a day. According to CNN ISIS has been selling this crude at roughly $25 a barrel. Which is much lower than the average of around $100 a barrel. My question is, how does this influx of cheap oil onto the market hurt or help the countries around Iraq?

One way to look at this question is to ask how this effects terms of trade for neighboring countries and Iraq. According to the CNN article, some of this oil is being sold in Iraq and Syria and some of it is being smuggled into Turkey. Turkey has been turning a blind eye to this black market. This increase or cheap oil onto the market reduces demand for oil sold on the regular market. This decrease in demand would lead to a decrease in price. This would improve Turkeys terms of trade if it regularly imports oil from Iraq. The price of their imports would decrease while the price of their exports would stay the same. On the other hand this price decrease would hurt Iraq’s terms of trade since the price of their imports would stay the same while the price of their exports decreased.

If ISIS continues its march deeper into Iraq, and is able to take over more and more oil fields, Iraq’s terms of trade could be seriously harmed. Although this could be good news for the U.S. since the influx of cheap oil on the black markets could keep the price of oil down lower than it should be. On the other hand, this could be bad news as well considering ISIS would become completely self-sufficient financially.

http://edition.cnn.com/2014/08/18/business/al-khatteeb-isis-oil-iraq/

Free Trade

http://www.nytimes.com/2014/10/04/opinion/sunday/our-misplaced-faith-in-free-trade.html?_r=0


Posted above is the link to an article written by Jeff Madrick of the New York Times.  I his article, entitled "Our Misplaced Faith in Free Trade," Madrick explains why he doesn't necessarily see more trade as a better thing.  He is skeptical of the new trade deals that the Obama administration is pursuing with the European Union and the Asian-Pacific region.  To summarize the article into one main point, Madrick says this:


1) Free trade creates winners and losers, and the American work force have been the losers.  Free trade has been a contributing factor to decreases in wages, and job security for Americans.  American wages have taken a hit because of outsourcing, and the heavy reliance on imports.  Madrick offers several instances in history where we need to look back and see the harm that was caused by removing barriers to trade and capital flows as well.


My reaction to this article is that Madrick has a very good point.  There needs to be certain limitations on imports and exports so your terms of trade and worker wages in the United States do not suffer.  Outsourcing and relying on imports heavily will drive the wages domestically down.  People at the top may be benefitting from these terms of trade, but the working class may suffer.  I'm not in any way opposed to the pursuit of new trading opportunities by the Obama administration, I just believe it should be done so while taking in full account the effect that it will have on the work force.

United States and European Union Brokering Trade Deal

The European Union and the United States are in the process of brokering a trade deal which would create the largest free trade zone in the world.  According to the attached article from the British Broadcasting Company representatives from both parties have been meeting on and off for the last year and recently held negotiations in Chevy Chase, Maryland.  The core of the deal which the European Union and the United States are trying to reach is the elimination of tariffs and “non-tariff obstacles” in order to “create opportunities for job-creating trade and investment.”  Some worry though that an agreement between the two entities would lower the quality of goods and the safety of products, while also causing their home countries to lose jobs.  

We have seen in class that by opening up more opportunities for trade, the United States and the European Union would both certainly benefit as they would be able to consume on higher indifference curves, bringing about overall higher utility for both entities.  Those who oppose the agreement which is being brokered are right though, some sectors may lose jobs even if overall utility goes up.  There will naturally be a shift in production for both the United States and the European Union, and while some of this will be an increase in production in various sectors, certainly just as much will be a shrink in production for specific sectors within either entity, causing some workers to lose their jobs.  More than likely the success of this deal will depend on the lobbying power of the sectors which will be affected and not on the economic sense of the deal.  

Labor Mobility

Labor is mobile factor, and workers tend to move to the sector having higher wages. It has good and also bad effects into economy. These two articles from World Bank are about Eurasian Economic Union, China and their new programs in labor control.

First article is about the pension mobility in Eurasian Economic Union. Eurasian Economic Union is an economic union between Belarus, Kazakhstan, and Russia. Under this new program, the workers have free movement in union, and they also receive the pensions from the countries where they are working and applying for the pension program. In my view, this program will simplify the pension mobility, give the workers better services and encourage the labor moving in union.

Second article is a brilliant idea in China. They have convenient classes in rural areas. They drive big trunks to the villages and turn them to be convenient classes to teach villagers new skills like driving or cooking. In the article, we can see some real examples. Ma Haihua’s income has increased 20 times after she attended the class and opened her own restaurant. Ma Shijie doubled his income after he learned how to operate an excavator. This program is extremely useful for developing countries. One of the main problems of developing countries is population. In rural areas, they have low education and have a lot of children. Then when the people can’t find jobs in villages, they go into cities and lead to overpopulation. In developing countries, they have big population, but the labor is less productive. This free training program will solve the problem.

References:
http://www.worldbank.org/en/news/press-release/2014/07/21/labor-migrants-pension-mobility-as-a-symbol-of-efficient-functioning-of-the-emerging-eurasian-economic-union

http://www.worldbank.org/en/news/feature/2014/09/01/new-skills-and-job-opportunities-for-china-rural-migrants

Explaining the shift for an increase in capital

A classmate asks the following question, which I could not figure out on-the-spot (paraphrasing):

If the capital stock increases by 10%, how do we know that the horizontal magnitude of that shift will be a 10% increase in labor demanded at each quantity (as opposed to a vertical increase of 10% as with a price increase)?

Great question and challenge accepted! But buckle your mathematical safety belts, it’s going to be a bumpy ride…

First, and as we have mentioned before, in Chapters 3 and 4 the book (and most trade models) assume constant returns to scale (CRS). Actually it does so in Chapter 2 as well, but the CRS assumption is trivial there given the even stricter assumption of linear a production function. I’ll use the example of a Cobb-Douglass production to “illustrate.”

Q = L^aK^{1 -a}.

By definition, along any isoquant, output is a constant level of revenue, i.e. Q = Q^*. This also means that along any isoquant, the change in Q is zero, i.e. dQ = 0:

dQ = aL^a-1K^{1 -a}dL + (1 - a)L^aK ^-adK= 0.

Solving for dK/dL, we have:

dL/dK = -(a/1 – a)(K/L).

In other words, the slope of the isoquant is the same for any given capital-labor ratio. The isoquants will look something like this (using a = 0.5 and Q = 1, 4, and 16):

Also, notice that the tangent lines in the graph represent costs of a given number of units of output, i.e. the equation of those lines represent wL + rK = C. Since they are tangent to the curves they also represent cost-minimizing combinations of L and K at a given Q. Additionally, the slopes are equal to the wage-rental ratio.

So, for a given market wage and a given market rental rate (return on capital), at any profit maximizing allocation of labor and capital (which will have to also be cost minimizing for that particular quantity of output), the proportion of capital to labor will be constant (as seen by the straight-line ray from the origin through the points of tangency).

Whew! Is our anonymous student glad to have asked about this yet?!? Anyway, returning to the “bucket,” and assuming CRS, and DK/K = 10%, then if the wage doesn’t change, then to maximize profits, labor in the manufacturing sector will have to increase by 10% (i.e. the quantity of labor demand will be 10% higher at each wage). This means that the shift will be a horizontal shift to the right by 10%. 

Jesus Fish and Greek Alphas

Jesus fish: 

Greek letter alpha:

           a

Note the pointy nose on the fish, versus the rounded front on the alpha.
This fun post brought to you by the letter "A" and the number 7.29735257×10^-3.
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