Question

Suppose the land is specific to agriculture, capital is specific to manufacturing, and labor is mobile between sectors. If there is an influx FDI into the country (increasing the amount of capital that is available), holding the prices of agriculture and manufacturing goods constant, what happens to the wage rate? What happens to the rental rate of capital? What happens to the rental rate of land? Explain your answer using the graph for the equilibrium in the specific-factor model.

Answer 1

Solutions:-
Increase in the amount of capital induce firms to produce more goods so demand of labor increases for the manufacturing. Increase in the demand of labor keeping the supply of labor constant lead to increase in the nominal wage rate in the manufacturing sector. Increase in wage in manufacturing sector attract more labor so labor will highly mobile from agriculture sector to manufacturing sector. As a result, more labor will be in manufacturing sector and less in the agriculture sector.

Supply of labor in the manufacturing sector increases due to migration and as a result, wage will decrease. Therefore, rental rate of capital will reduce while due to decrease in the supply of labors in the agriculture, rental rate of land increases.

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