Fall2014 Econ 471

Problem Set #4

COVER PAGE TO PROBLEM SET #4

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While you are permitted to work together as a group, you must write out the answers on your own (preferably in a separate room) without any help from those in the group. Problem sets with similar answers in any question will receive a grade of zero.

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Unless your handwriting is clear and impeccable, you must turn in typed answers to the problem sets. Hard copies of your answers will be handed in the beginning of class onTuesday, Nov 18. No late problem sets will be accepted.

1. The following table provides data on the Labor hours per unit of production of two goods, cell phones and TVs in the two countries, U.S. and Brazil.

a. Complete the last column of the table above.

b. Compared to Brazil, the US is more efficient in producing both goods. Why does it still benefit the U.S. to trade with Brazil?

c. Pick a feasible terms of trade and show and explain how the U.S. can benefit from trading with Brazil at the chosen terms of trade.

2. In the late 1980s, Vietnam went from an essentially closed economy to one that is highly integrated with the world economy in terms of trade in goods and services. Since 1990, the growth in GDP per capita in Vietnam has been exceptional reaching double digits. Use the following simplifying assumptions to answer questions a) to c):

l Vietnam produces two goods: rice (labor intensive) and computers (capital intensive).

l Vietnam is relatively labor abundant, and the domestic price of rice relative to price of computers is lower than that in the world market.

l Resources used in production can move across sectors when economic conditions change.

a. Which good does Vietnam export? Which good does it import?

b. Using the tools discussed in class, show graphically the change in overall welfare in Vietnam from liberalizing its trade policy. Your graph should use a two-good framework with the good that Vietnam exports on the x-axis and its importable good on the y-axis.

c. Who are the winners and losers in Vietnam from this change in trade policy?

3. In China, three members of a family own a small business. They can hire up to two more people to work in their business. Each worker is paid $300. The total output per year depends on the number of members working in the business that year. Total annual income (or value of output) is represented by the following chart.

Each member of the family has the opportunity to migrate to the nearest city where there are two different types of jobs. Informal jobs are available to everybody and pay $200. Formal sector jobs are more difficult to get and pay $800. The probability of finding a job in the formal sector is 60%. For questions A-C, suppose that there are no costs of migration.

a. Suppose all three members of a family were to work in the business. How many workers should the family hire to maximize business Profit? Show your work.

b. What is the expected wage in the city? Show your work.

c. Show that the business maximizes total family income by sending two of their family members into the city, letting one stay on the farm and hiring two workers.

4. Consider a country with production function, savings rate, and capital depreciation rate.

a. What is the level of capital per worker () and output per worker () when the country is closed to capital flows? (Hint: Solow model)

b. What is the level of and when the county becomes perfectly open to capital flows? Assume the world rental rate of capital is. Show your derivations. (Hint: free-capital-flow model we discussed in class, Weil Ch.11)

c. Use your answers to a) and b), explain why higher savings rates are associated with higher levels of GDP in a closed economy, but they are not in an open economy.

d. Does the statement in c) mean that if you save a lot, you are better off in a closed economy? Why or why not?

5. Read the following article on immigration and answer the following questions

a. Explain the term brain drain? Why is it an issue to the policymakers in poor countries?

b. Explain the term brain gain? What is the key aspect that turns brain drain into brain gain?

c. Besides direct remittance (sending income back to home country), name two other sources of potential gains to the sending country from skilled emigration.

Drain or gain? Poor countries can end up benefiting when their brightest citizens emigrate

Economics focus | May 26th 2011 | from the print edition

WHEN people in rich countries worry about migration, they tend to think of low-paid incomers who compete for jobs as construction workers, dishwashers or farmhands. When people in developing countries worry about migration, they are usually concerned at the prospect of their best and brightest decamping to Silicon Valley or to hospitals and universities in the developed world. These are the kind of workers that countries like Britain, Canada and Australia try to attract by using immigration rules that privilege college graduates.

Lots of studies have found that well-educated people from developing countries are particularly likely to emigrate. By some estimates, two-thirds of highly educated Cape Verdeans live outside the country. A big survey of Indian households carried out in 2004 asked about family members who had moved abroad. It found that nearly 40% of emigrants had more than a high-school education, compared with around 3.3% of all Indians over the age of 25. This brain drain has long bothered policymakers in poor countries. They fear that it hurts their economies, depriving them of much-needed skilled workers who could have taught at their universities, worked in their hospitals and come up with clever new products for their factories to make.

Many now take issue with this view (see article). Several economists reckon that the brain-drain hypothesis fails to account for the effects of remittances, for the beneficial effects of returning migrants, and for the possibility that being able to migrate to greener pastures induces people to get more education. Some argue that once these factors are taken into account, an exodus of highly skilled people could turn out to be a net benefit to the countries they leave. Recent studies of migration from countries as far apart as Ghana, Fiji, India and Romania have found support for this brain gain idea.

The most obvious way in which migrants repay their homelands is through remittances. Workers from developing countries remitted a total of $325 billion in 2010, according to the World Bank. In Lebanon, Lesotho, Nepal, Tajikistan and a few other places, remittances are more than 20% of GDP. A skilled migrant may earn several multiples of what his income would have been had he stayed at home. A study of Romanian migrants to America found that the average emigrant earned almost $12,000 a year more in America than he would have done in his native land, a huge premium for someone from a country where income per person is around $7,500 (at market exchange rates).

It is true that many skilled migrants have been educated and trained partly at the expense of their (often cash-strapped) governments. Some argue that poor countries should therefore rethink how much they spend on higher education. Indians, for example, often debate whether their government should continue to subsidise the Indian Institutes of Technology (IITs), its elite engineering schools, when large numbers of IIT graduates end up in Silicon Valley or on Wall Street. But a new study of remittances sent home by Ghanaian migrants suggests that on average they transfer enough over their working lives to cover the amount spent on educating them several times over. The study finds that once remittances are taken into account, the cost of education would have to be 5.6 times the official figure to make it a losing proposition for Ghana.

There are more subtle ways in which the departure of some skilled people may aid poorer countries. Some emigrants would have been jobless had they stayed. Studies have found that unemployment rates among young people with college degrees in countries like Morocco and Tunisia are several multiples of those among the poorly educated, perhaps because graduates are more demanding. Migration may lead to a more productive pairing of people’s skills and jobs. Some of the benefits of this improved match then flow back to the migrant’s home country, most directly via remittances.

The possibility of emigration may even have beneficial effects on those who choose to stay, by giving people in poor countries an incentive to invest in education. A study of Cape Verdeans finds that an increase of ten percentage points in young people’s perceived probability of emigrating raises the probability of their completing secondary school by around eight points. Another study looks at Fiji. A series of coups beginning in 1987 was seen by Fijians of Indian origin as permanently harming their prospects in the country by limiting their share of government jobs and political power. This set off a wave of emigration. Yet young Indians in Fiji became more likely to go to university even as the outlook at home dimmed, in part because Australia, Canada and New Zealand, three of the top destinations for Fijians, put more emphasis on attracting skilled migrants. Since some of those who got more education ended up staying, the skill levels of the resident Fijian population soared.

Passport to riches

Migrants can also affect their home country directly. In a recent book about the Indian diaspora, Devesh Kapur of the University of Pennsylvania argues that Indians in Silicon Valley helped shape the regulatory structure for India’s home-grown venture-capital industry. He also argues that these people helped Indian software companies break into the American market by vouching for their quality. Finally, migrants may return home, often with skills that would have been hard to pick up had they never gone abroad. The study of Romanian migrants found that returnees earned an average of 12-14% more than similar people who had stayed at home. Letting educated people go where they want looks like the brainy option.

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