In this question you are asked to analyze the eect of international trade on the de-

mand for domestic labor. To this end, assume that output is produced according to

a production function

Y

=

F

N

F

; N

D

, where

N

F

is the amount of foreign labor

employed in the production of output

Y

, and

N

D

is its domestic counterpart. Their

costs per unit are

w

F

and

w

D

, respectively. Assume that the increased openness of an

economy is represented by a decrease in the cost of foreign labor,

w

F

.

(a) Write down the cost function of the rm.

(b) Consider an initial level of labor costs,

w

F

0

; w

D

0

. Using three carefully labelled di-

agrams with

N

D

on the

x

axis and

N

F

on the

y

axis, show the cost-minimizing

combination of inputs for the cases of (i) perfect substitutes; (ii) perfect comple-

ments and (iii) an in-between case. Explain verbally why the point you show in

the gure is cost minimizing.

(c) Assume that

w

F

decreases from

w

F

0

to

w

F

1

, but that

w

D

stays at its original level

w

D

0

. Analyze graphically the eect of this decrease of the cost of foreign labor on

N

D

, using three new graphs. Again, consider the same three cases of production

functions as in part (b). In each case, show the substitution- and the scale eects.

1

(d) What is the dierence between outsourcing and hiring foreign labor?

(e) You are now asked to read two academic papers that study the labor market eect

of international trade empirically. Both papers are posted on Canvas: