Question Overview

Computer production consists of two steps: components production, and assembly. Both steps require skilled and unskilled labor. Until now, computers were produced entirely in the U.S. to serve U.S. consumers. Unskilled workers earn $10 an hour, while skilled workers earn $30 an hour in the U.S. With technological advances, manufacturers are now able to relocate their production process in China where the wages are lower: unskilled workers earn $2 an hour, while skilled workers earn $10 an hour. The following summarizes the unit labor requirements:

Suppose that shipping components between the U.S. and China cost $10 per computer, while shipping assembled computers cost $50 per computer. The firm’s expected U.S. demand for computers (QUS) is 1.5 million.

i. Where will you manufacture components and assemble computers for consumers in the U.S. market? What will be the production cost of a computer?

ii.  Relocating the production process to China, in fact, involves a fixed cost of setting up a plant, which is $120 million. Is it better to move (a part or all of) the production process to China?

iii. China is a big market for computers. While the expected demand QCHN is unknown, you know that you can charge PCHN = $435 per computer. What is the best way to organize production for the U.S. and Chinese markets? What is the minimum level of QCHN that would justify your Chinese operations?

Now suppose that you learn about the recent escalation of the trade war between the U.S. and China. The welfare of both countries was estimated at 10 (all units are denominated in millions) under free trade. When both decide on imposing import tariffs (i.e. a specific tariff of $10 per computer components and $50 per computer for the assembled computer), both are expected to experience a welfare loss (-10). In the event of only one country imposing high tariffs (and the other does not), the estimated welfare of this country with protectionist measures would be 40 while the other country suffers a welfare loss (-30).

iv.What is the expected outcome of this trade war?

v. How does your answer in part (iii) change?

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