MGEC62+Solution+Set_Specific+Factors.pdf - University of...

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Page 1 of 11 University of Toronto at Scarborough Department of Management International Economics: Trade Theory MGEC62 The Specific Factors Model Trade has considerable effects on the income distribution within each trading nation. There are two main reasons why international trade has strong effects on the distribution of income: resources cannot move immediately or costlessly from one industry to another and industries differ in the factors of production they demand. The Specific Factors model allows trade to affect income distribution. The question addressed by the model is how trade, through changes in relative prices, affects the earnings of labor, land, and capital. The Specific Factors model’s name refers to its distinguishing feature; that one factor of production is assumed to be “specific” to a particular industry. Labor is the mobile factor that can move between the two sectors in question. Each of the other two factors, land and capital, are assumed to be specific to a particular industry. A specific factor is one which is stuck in an industry or is immobile between industries in response to changes in market conditions. In the Heckscher-Ohlin model, both factors, capital and labor, were assumed to be mobile. Recall that in production decisions, some factors are fixed (and hence specific) in the short-run, but all facts are variable inputs in the long-run. Thus, the Heckscher-Ohlin model is a long-run model, whereas the Specific Factors model us a short-run model in which capital and land inputs are fixed but labor is a variable input in production. Problem 1 Manufacturing: Sales Revenue = P M · Q M = 150 Payments to Labor = W · L M = 100 Payments to Capital = R K · K = 50 Agriculture: Sales Revenue = P A · Q A = 150 Payments to Labor = W · L A = 100 Payments to Capital = R T · T = 50 Holding the price of manufacturing constant, suppose the increase in the price of agriculture is 20% and the increase in the wage is 10%. a) Determine the impact of the increase in the price of agriculture on the rental on land and rental on capital Answer: Rental on land can be calculated as follows: R T R T = ( P A / P A ) · P A Q A - ( W / W ) · WL A R T · T R T R T = 20% · 150 - 10% · 50 100 = 25% Recall that the price of manufacturing remained constant, we get the rental on capital as:
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Page 2 of 11 R K = 0 · Q M - W · L M K R K R K = – W W · W · L M R K · K R K R K = –10% · 100 50 = –20% b) Explain what has happened to the real rental on land and the real rental on capital Answer: Because of the 20% increase in the price of agriculture, the real rental on land rose, whereas the real rental on capital fell. Therefore, landowners are better off because the percentage increase in the rental on land is greater than the percentage increase in the price of agriculture, whereas the price of manufacture is constant. Capital owners are worse off in terms of their ability to purchase both manufacture and agriculture because the rental to capital has fallen.
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