Question

Consider a country, Home, which produces two goods, Cloth and Food, using capital and labour with a constant-return-to-scale technology. Food production is capital-intensive and cloth production is labour-intensive. Capital and labour can move freely between the two industries. Finally, let’s assume that Home’s consumption decisions can be represented using regularly-shaped indifference curves.

3. What will be the impact of the price change on the wage rate and the rental rate of capital in Home? Make sure that you provide the theoretical basis for your answer? (8 points) 4. Would the change in labour endowment affect existing trade pattern in Home? Discuss! (10 points)

Answer 1

The regular indifference curve represent the home's consumption decision. the below graph shows the indifference curve.

3) Price change will have an impact on wage rate and rental rate. Price has a spiral relationship with wages and rent. So as the price increase the labourers will demand and the wages will increase, and as the price increase the demand for land will increase hence the rental rents will also increase. So the spiral effect will have an impact on the above mentioned component.

4) Yes the labour endowment of a country tells alot about the country's trade pattern. As we see here the food is capital intensive and cloth is labour intensive. Any change in the endowment will change this pattern. There will be some trade off in the the cloths and food. The consumption pattern will become unstable and the composition will differ.