Y5

Part 4: Offshoring numerically, v.2 ["tangency analysis"] "Home" has 100 units of labor that are specific to the production of R&D, and 25 units of labor that are specific to the production of components; there are 100 units of capital that can be allocated either to R&D or to components. The production function is =^(1/2)^(1/2) for components and =^(1/2) ^(1/2) for R&D; final goods are produced from components and R&D according to the function =^(1/2)^(1/2).

a) Write down an expression for the PPF for components and R&D in this country. Compute the "autarky" (or "no-offshoring") equilibrium production of components, R&D, and final goods, and the allocation of capital between components and R&D. If each unit of components is worth $10, then what is the price of a unit of R&D in this equilibrium? Illustrate your results with a PPF-isoquant diagram.

b) Now suppose R&D and components are traded on international markets at equal prices (i.e. = =1). Solve for the equilibrium under offshoring: compute the domestic production of components, R&D, and final goods, and the domestic allocation of capital in this equilibrium. Show the new equilibrium in your diagram from part a (or in a new PPF-isoquant diagram).

c) How does offshoring affect the earnings of each unit of capital and of each type of labor in this economy? To be numerically precise, you can assume that offshoring causes the price of one intermediate good to rise while the other one remains the same.

d) In the spirit of Samuelson, discuss in words how this country would be affected by changes in the terms of trade (i.e. fluctuations in / ) once offshoring has begun.