Problem2_answers

Problem2_answers - Prof. Anca Cristea Answers:...

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Unformatted text preview: Prof. Anca Cristea Answers: Problem Set 2 EC 481/581 Spring 2011 PART A: Specific Factor Model 1. Use the information given here to answer the following questions: Manufacturing: Sales Revenue = PM*QM = 150 Payments to Labor = W*LM = 100 Payments to Capital = RK*K = 50 Agriculture: Sales Revenue = PA*QA = 150 Payments to Labor = W*LA = 50 Payments to Land = RT*T = 100 Holding the price of manufacturing constant, suppose the increase in the price of agriculture is 10% and the increase in the wage is 5%. a. Calculate the impact of the increase in the price of agriculture on the rental rate for land and the rental rate for capital. b. Explain what has happened to the real rental for land and the rental rate for capital. Prof. Anca Cristea EC 481/581 Spring 2011 2. In the specific factors model examined in class, assume that the price of the agricultural good decreases while the price of the manufactured good remains unchanged (i.e., ΔPA/PA<0 and ΔPM/PM = 0). Draw the ‘Bucket’ diagram showing the change in labor allocation and wages. Using information from the diagram, arrange the following terms in ascending order: ΔPA/PA Wages PM * MPLM PA * MPLA PA’ * MPLA ΔPM/PM ΔRT/RT ΔRK/RK ΔW/W W W ’ OM A B LM L L’ LA OA The general rule for the specific factors model is that a decrease in the relative price of an industry leads to a real loss of the factors specific in that industry, and a real return to the specific factor in the other industry. This means that the percentage change in losses to land is greater than both price changes and that the percentage change in returns to capital is greater than both price changes, which is equivalent to saying that fewer of both goods can be purchased by landowners although more of both goods can be purchased by capital owners. 3. Suppose two countries, Canada and Mexico, produce two goods: timber and televisions. Assume that land is specific to timber, capital is specific to televisions, and labor is free to move between the two industries. When Canada and Mexico engage in free trade, the relative price of televisions falls in Canada and the relative price of timber falls in Mexico. a. Using a ‘Bucket’ diagram like the ones drawn in class, show how labor in Canada is initially allocated between the timber and television industries. Then, show how the wage changes in Canada due to a fall in the price of televisions, holding constant the price of timber. Can we predict that change in real wages? Prof. Anca Cristea EC 481/581 Spring 2011 The real wage in terms of TVs increases. You can see this by comparing the change in wages with the vertical distance between the PTV MPLTV curve and PTV ' MPLTV : ΔW ΔPTV MPLTV ΔPTV but since ΔP is a negative number => w’/P’>w/P < = W PTV MPLTV PTV € € The real wage in terms of timber decreases: € W' = MPLTIM ↓ , as a result of an PTIM increase in the amount of labor used in the timber industry. b. What is the impact of opening trade on the rental rates for capital and land in € Canada? Can we predict that change in the real rental rates for capital and land? c. What is the impact of opening trade on the rental rates for capital and land in Mexico? Can we predict that change in the real rental rates for capital and land? d. In each country, has the specific factor in the export industry gained or lost? Has the specific factor in the import industry gained or lost? Prof. Anca Cristea EC 481/581 Spring 2011 4. In the short-run specific factors model discussed in class, consider a decrease in the stock of land an economy has. For example, suppose a natural disaster decreases the quantity of arable land used for planting crops. a. Use a diagram to show how this change impacts the labor allocation between manufacturing and agriculture. b. What is the effect of this change in land on the quantity of labor in each industry and on the equilibrium wage? Explain. c. What is the effect on the rental rate for land and capital? Explain. Prof. Anca Cristea EC 481/581 Spring 2011 PART B: True/ False For each question, answer T/F/U and briefly explain the answer (No points for an unsupported answer). 1. In theory, national gains from trade permit the winners from freer trade to compensate the losers from freer trade and still leave everyone better off. True. In the absence of political frictions, some of the national gains from trade can be transferred from those who gain from trade to those who lose from trade. The pie is larger with trade than without. 2. In the specific factors model with mobile labor and sector ­specific capital in both sectors, the return to capital must be the same in both sectors. False. Since capital is not mobile in the short run, returns to capital across sectors need not equalize. 3. A decrease in the capital ­labor ratio raises the marginal product of capital. True. When the capital labor ratio falls, diminishing returns to capital operates in reverse. Now, each unit of capital has more labor to operate it and generates more output at the margin. 4. In the specific factors model, the slope of the production possibility frontier (PPF) is a straight line because of constant returns in production. False. In the specific factors model the slope is changing along the PPF because of diminishing returns in the use of factors of production. 5. One difference between the Ricardian model and the Specific Factors Model of trade is that in the former model the marginal product of labor is constant, while in the latter it is a decreasing function of labor. True. By assumption, the marginal product of labor in the Ricardian model is constant and therefore independent of the total amount of labor employed in an industry. In contrast, in the specific factors model the marginal product of labor is decreasing with more workers added to the industry because of the fixed quantity of the immobile (specifc) factor of production. 6. Both the Ricardian model and the Specific Factors Model of trade predict that once a country opens up to trade, it completely specializes in the comparative advantage good. False. The Ricardian model of trade predicts full specialization in the comparative advantage good, once the country opens up for trade. However, in the specific factors model of trade a country continues to produce both goods even when international trade is allowed to take place. Because of diminishing returns, as the mobile factors (labor) start entering the export sector, then the benefit of the higher trade prices is eroded by a lower marginal product of labor. ...
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This note was uploaded on 04/27/2011 for the course ECON 481 taught by Professor Ancacristea during the Spring '11 term at Oregon.

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