21 Offshoring Assume producing a car requires three tasks: A (the design), B (th

Question

21 Offshoring Assume producing a car requires three tasks: A (the design), B (the electronics), and C (the body of the car). Task A is the most skilled intensive. It requires 6 skilled workers and3 unskilled workers. Task B is the second most skilled intensive task: it requires 4 skilled and 4 unskilled workers. Task C is the least skilled intensive, it requires 3 skilled workers and 6 unskilled workers. Some of these tasks are performed in the U.S., and some in Mexico The relative supply for skilled labor in the U.S. is given by: WU Lu and the relative supply for skilled labor in Mexico is given by: =2.lg LU WU a) Initially, tasks A and B are performed in the U.S. and task C is performed in Mexico. Compute the relative demand for skilled labor in the U.S. and Mexico. Find the relative wage for skilled labor (the skill premium) in the U.S. and Mexico. b) Due to a decline in offshoring costs, task B is moved to Mexico. This means task A is done in the U.S. and tasks B and C are performed in the U.S. and task C is performed in Mexico. Compute the relative demand for skilled labor in the U.S. and Mexico. Find the relative wage for skilled labor in the U.S. and Mexico. What happened to the skill premium in each country?

Explanation / Answer

a) Initially, task A and B are performed in US and task C is performed in Mexico.

So Relative demand for skilled labor in US is (6+4)/(3+4)

= 10/7.

In equilibrium, relative demand for skilled labor has to be equal to relative supply of skilled labor at the market clearing relative wage.

So Ws/Wu = 10/7 in US

In Mexico, relative demand for skilled labor is given by 3/6 = 1/2.

Thus in equilibrium, Ws/Wu = 1/2 in Mexico.

b) Now task B is moved to Mexico.

Now, US performs only task A. So relative demand for skilled labor in US is 6/3 = 2

Thus Ws/Wu= 2 in US.

Since Mexico performs both B and C, relative demand for skilled labor is (4+3)/(4+6) = 7/10.

Thus Ws/Wu= 7/10 in Mexico.

It is clear that Relative wage of skilled labor has increased in both US and mexico. This has happened in US because now US is left with a very skill-intensive task(only task A). This happened in Mexico because now Mexico has shifted to More skill-intensive tasks along with task C. Thus relative demand for skilled labor has increased in both countries. Thus relative wages of skilled labor have increased in both countries.

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