Consider a small open economy that produces manufacturing goods (M) and health services (S). Both goods require the use of skilled labor (H) and low skilled labor (L). In order to produce a manufacturing good a firm needs to employ two low skilled workers (aML=2) and two high skilled workers (aH=2). In order to produce a health services a firm needs to employ one low skilled worker (aSL=1) and two high skilled workers (aH=2). We assume that the markets are competitive, and these two types of labor are the only two inputs used in the production of the goods.

a.) If the world prices of the manufacturing good and health services sre $30 and $25 respectively, assuming no tasks could be offshored what is the wage rate paid to low skilled (WL) and high skilled workers (WH). (Hint: Recall PM = WL*aML+WH*aH and PS = WL*aSL+WH*aH ).

b.) Suppose that some of the tasks of high-skilled workers could be offshored and that the costs of offshoring the tasks are the same for health services and manufacturing. Also assume the wage rate of high-skilled workers in the foreign country was $4 and workers in the foreign industry were half as productive as high-skilled workers; that is, a*H = aH where =2. Finally, we assume that there are no costs associated with contracting with domestic workers, but it is costly to contract with foreign workers. Suppose we can organize the tasks by increasing complexity and costs of contract as follows: T(z) = (1+z) where the range of tasks are from 0 to 1 and the costs of tasks are proportional to the cost of the task; that is, the cost of completing task z by a foreign worker is W*Ha*H(1+z). Which tasks will be carried out at home and which tasks will be carried out by foreign workers? Draw a figure that depicts this cut-off.

c.) Suppose workers in the foreign economy became more productive and so that domestic workers were only 75% more productive than foreign workers; this implies = 7/4 rather than 2. Show graphically what happens to the range of tasks performed by the home workers and foreign workers. Calculate the new range of activities.

d.) Intuitively explain how this change of productivity of workers will impact profits, the return to low-skilled labor and the return to high-skilled labor.