International Trade - Theory and Policy, 2010a

expansion of output in the export sector (the sector whose price rises) and a reduction in output in the
import-competing sector. The adjustment would continue until the wage rises to a level that equalizes the
value of the marginal product in both industries.
The return to capital in response to the price change would vary across industries. In the importcompeting
industry, lower revenues and higher wages would combine to reduce the return to capital in
that sector. However, in the export sector, greater output and higher prices would combine to raise the
return to capital in that sector.
The real effects of the price change on wages and rents are somewhat more difficult to explain but are
decidedly more important. Remember that absolute increases in the wage, or the rental rate on capital,
does not guarantee that the recipient of that income is better off, since the price of one of the goods is also
rising. Thus the more relevant variables to consider are the real returns to capital (real rents) in each
industry and the real return to labor (real wages).
Ronald Jones (1971) derived a magnification effect for prices in the SF model that demonstrated the
effects on the real returns to capital and labor in response to changes in output prices. In the case of an
increase in the price of an export good and a decrease in the price of an import good, as when a country
moves to free trade, the magnification effect predicts the following impacts:
1. The real return to capital in the export industry will rise with respect to purchases of both exports and imports.
2. The real return to capital in the import-competing industry will fall with respect to purchases of both exports and
imports.
3. The real wage to workers in both industries will rise with respect to purchases of the import good and will fall with
respect to purchases of the export good.
This result means that when a factor of production, like capital, is immobile between industries, a
movement to free trade will cause a redistribution of income. Some individuals—owners of capital in the
export industry—will benefit from free trade. Other individuals—owners of capital in the importcompeting
industries—will lose from free trade. Workers, who are freely mobile between industries, may
gain or may lose since the real wage in terms of exports rises while the real wage in terms of imports falls.
If workers’ preferences vary, then those individuals who have a relatively high demand for the export good
will suffer a welfare loss, while those individuals who have a relatively strong demand for imports will
experience a welfare gain.
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