1.United States and Mexico have two industries; call them, L-intensive (LIN) and K-intensive (KIN). They have two factors of production: labor and capital. US is a capital abundant country and Mexico is a labor abundant country. At the initial equilibrium, US exports KIN product to Mexico and Mexico exports LIN product to the US. Now suppose that there is a massive immigration from Mexico to the US.
a.Show and explain how this immigration flow will affect each country’s PPFs.
b.What happens to relative supply of LIN to KIN in the world market and why?
c. If we assume that the world production of LIN to KIN falls as a result of immigration flow then what happens to terms of trade and welfare in two countries? Show graphically.
a. To understand how the immigration flow will affect each country's production possibilities frontiers (PPFs), we need to first understand the factors of production and the existing trade patterns.
In the initial equilibrium, the US exports KIN (K-intensive) products to Mexico, while Mexico exports LIN (L-intensive) products to the US. This suggests that the US has a comparative advantage in producing KIN products, while Mexico has a comparative advantage in producing LIN products.
Now, with a massive immigration flow from Mexico to the US, the labor supply in the US increases significantly. This means that the US becomes relatively more abundant in labor compared to capital.
Given that the US is already capital-abundant, the increase in the labor supply from immigration will likely lead to a decrease in the capital-labor ratio in the US. As a result, the US will experience a shift in its PPF outward in the LIN (labor-intensive) direction and inward in the KIN (capital-intensive) direction. This is because the US can now allocate more labor towards producing LIN products, taking advantage of the newly available labor force.
On the other hand, with a substantial decrease in the labor supply in Mexico, the country becomes relatively more abundant in capital compared to labor. This will likely lead to an increase in the capital-labor ratio in Mexico. As a result, Mexico will experience a shift in its PPF outward in the KIN (capital-intensive) direction and inward in the LIN (labor-intensive) direction. This is because Mexico can now allocate more capital towards producing KIN products, utilizing the increased availability of capital.
b. The relative supply of LIN to KIN in the world market will likely change due to the immigration flow. With the increase in labor supply in the US, the US will have a higher relative supply of LIN compared to KIN in the world market. Conversely, with the decrease in labor supply in Mexico, Mexico will have a higher relative supply of KIN compared to LIN in the world market.
This change in relative supply is because the immigration flow has increased the labor-intensive production in the US (LIN) while decreasing it in Mexico, leading to a higher supply of LIN products in the world market. Similarly, the immigration flow has also increased the capital-intensive production in Mexico (KIN) while decreasing it in the US, resulting in a higher supply of KIN products in the world market.
c. If we assume that the world production of LIN to KIN falls as a result of the immigration flow, the terms of trade and welfare in both countries may be affected.
Graphically, if the world production of LIN to KIN falls, it means that the relative demand for LIN products has increased compared to KIN products. This can be shown by a shift in the world relative demand curve to the right.
In terms of the terms of trade, if the relative supply of LIN products in the world market has increased due to the immigration flow, and the relative demand for LIN products has also increased, then the terms of trade for LIN products will likely improve for Mexico. Mexico can now obtain more units of KIN products in exchange for a given amount of LIN products.
On the other hand, the terms of trade for KIN products will likely deteriorate for Mexico and improve for the US. The US can now obtain more units of LIN products in exchange for a given amount of KIN products, while Mexico needs to export more KIN products to receive the same amount of LIN products.
In terms of welfare, if Mexico's terms of trade for LIN products improve, it can benefit from higher export revenues and potentially experience an increase in welfare. However, if the terms of trade for KIN products deteriorate for Mexico, it may lead to a decrease in welfare. Similarly, the US may experience higher welfare due to improved terms of trade for KIN products but may face a decrease in welfare due to deteriorated terms of trade for LIN products.