1. Consider an offshoring model in which the hours of labor used in four activities in the United States and Mexico are as follows: Note that labor hours in Mexico are twice those in the United States, reflecting Mexico’s lower productivity.

Also note that the ratio of high-skilled to low-skilled labor used in each activity increases as we move to the right, from 1/5 in assembly, to 10/1 in R&D. Suppose that the wage of U.S.

low-skilled workers is $10 per hour and that of high-skilled workers is $25 per hour, and that the wage of Mexican low-skilled workers is $1 per hour and that of high-skilled workers is $5 per hour (these values are made up to be convenient, not realistic). Also suppose that the trade costs are 25%, 30%, or 50%, which means that an additional 25%, 30%, or 50% is added to the costs of offshoring to Mexico.

a. Fill in the blank cells in the following table by computing the costs of production of each activity in each country (two cells are filled in for you):

b. With trade costs of 50%, where is the value chain sliced? That is, which activities are cheaper to import from Mexico and which are cheaper to produce in the United States?

c. With trade costs of 30%, and then 25%, where is the value chain sliced?

Transcribed Image Text:

Hours of Labor Used in Each Activity (per unit of output): Assembly Component Production Office Services R&D Low-skilled labor Mexico: 20 Mexico: 12 Mexico: 8 Mexico: 4 U.S.: 5 U.S.: 3 High-skilled labor Mexico: 4 Mexico: 4 U.S.: 2 Mexico: 8 U.S.: 1 Mexico: 40 U.S.: 1 U.S.: 1 U.S.: 2 U.S.: 10 High-skilled/low-skilled ratio 1/5 1/3 1/1 10/1