Question

Consider an economy with two sectors: clothing and car production. There are two factors used in...

Consider an economy with two sectors: clothing and car production. There are two factors used in the production of both industries: labor, mobile between the industries and capital specific to each industry. This economy is involved international trade, then in case the world price of cars decreases and price of clothes does not change:

A.Nominal earnings of capital owners in car industry will decrease, real earnings of capital owners in clothes industry will decrease
B.Real earnings of capital owners in car industry will increase, nominal earnings of capital owners in clothes industry will increase
C.Nominal earnings of capital owners in car industry will increase, nominal earnings of capital owners in clothes industry will increase
D.Real earnings of capital owners in car industry will decrease, real earnings of capital owners in clothes industry will increase
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Answer #1

Option (C) is the correct option

Because as world price of cars decreases, its supply would increase in the market and more factors of production will be employed like more labor will move towards car industry and more capital will be used. In the short run, nominal wages donot change but real wages would fall as price of output falls. In the long run, real wages will be constant so nominal wages would increase by the same amount as price of output decreased.i.e nominal earnings of capital owners in car industry will increase and so they will demand a higher wage in clothes industry as well. This implies that nominal earnings of captial owners in clothes will also increase.

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