Question

1.) According to the factor price equalization theorem, if Thailand consummates a free trade agreement with Australia, what should happen to Thai and Australian wages (you may assume that Thailand is the relatively capital abundant country).

2.) Suppose there are two factors of production in Guatemala, land and unskilled workers. If you read that the union representing unskilled laborers is protesting the proposed free trade agreement with Mexico, what can you conclude about relative factor abundance in Guatemala? Explain.

Answer 1

According to the factor price equalization theorem, the factor prices of countries that trade with each other are equalized.

If Thailand enters into an agreement with Australia in free trade of commodities of which factor of productions are identical say capital and labor, the difference of wage rate and rate on interest will come to end. Both will equalize. If Thailand is relatively capital abundant then the rental rate will be lower in comparison to Australia. So Australia will develop more capital so that MPC becomes equal for both countries.