Question

2. Use the specific-factors model to answer question 2. Assume that there are two industries, food and cloth. The food industry uses labor and land as inputs while the cloth industry uses labor and capital as inputs. The marginal product of labor in both industries is as follows:

                   Marginal Product of Labor

Labor            Cloth                   Food

0               1.4                    1.6

1               1.3                    1.5

2               1.2                    1.4

3               1.1                    1.3

4                1                     1.2

5                .9                    1.1

6                .8                     1

7                .7                     .9

8                .6                     .8

9                .5                     .7

10                .4                     .6

Assume that initially that there is no trade and that the price of food and the price of cloth are both equal to 1. Assume that the total size of the labor force is equal to 10.

1. Suppose that international trade causes the price of cloth to rise 50% (to 1.5), while the price of food remains constant. What is the new equilibrium wage rate in dollar terms (w)? How much labor is hired by the food industry and how much by the cloth industry?
2. What has happened to the purchasing power of the wage in terms of cloth (i.e what has happened to w/P_c)? What has happened to the purchasing power of the wage in terms of food (i.e what has happened to w/P_F)?
3. What is the amount of income to landowners now, both in dollar terms, and in the amount of cloth and food it can buy (income/P_c and income/P_F)?
4. What has happened to the income to capital owners, both in dollar terms, and in the amount of cloth and food it can buy?

Answer 1