Question

In the short-run specific-factors model, consider a decrease in the stock of land. For example, suppose...

In the short-run specific-factors model, consider a decrease in the stock of land. For example, suppose a natural disaster decreases the quantity of arable land used for planting crops.

a. Explain the effect on wages using a graph similar to 5.1 in your textbook

b. What is the effect on the rental on capital?

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Answer #1

a) Reduction in the amount of land with same amount of workers in total, would reduce marginal product of labor engaged in agriculture. This will also reduce VMPL in agriculture so that demand function for labor in agriculture will fall. This will reduce agricultural wage and workers will migrate to manucaturing. This migration increases labor supply in manufacturing so that wage rate in manufacturing fall as well.

b) Capital is specific to manufacturing. With falling wage rate, capital is replaced by workers so demand for capital falls. This reduces its rental price.

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