Economics of Outsourcing

Analysis

Model Assumptions and Backgroud  

1. Small country case (no effect on world prices)

2. 2 inputs, K and L (no specific factors)

3. 2 goods, x and y; y is export good, x is import good (or import competing industry within country)

4. K-abundant country

5. Industry X (and import competing industry) outsources L-intensive components of good x

Figure 1

Figure 1


Figure 2

Figure 2

The country decides to outsource L-intensive components of good x.

Figure 3

Figure 3


Figure 4

Figure 4

Thus ends the comparative statics of our model. In the figure below, we will analyze some additional effects of outsourcing by looking at the "starting point" (initial endowment of K, L; allocations of K, L to each good) and the and the end result.

Figure 5: Additional Effects

Figure 5


Summary

We find that wages have increased, and more amounts of labor are utilized in industry X--the import competing goods sector. The results of this model contradict the claim that outsourcing reduces wages and reduces employment. For a more in-depth explanation of the theory behind outsourcing, see "Globalization and the Open Economy" by Sven W. Arndt.