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3610 PS2 solution

3610 PS2 solution - Cornell University Fall 2009 Economics...

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Cornell University Fall 2009 Economics 3610: Problem Set 2 Solutions 1. Specific Factors (Question 9 of Chapter 3 of Text) 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.In a graph similar to Figure 3-6, 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 the change in the real wage? If the price of televisions falls, the P TV *MPL TV curve shifts down. Labor shifts into timber from televisions, and the nominal wage falls. With more labor in timber and the amount of land fixed, the marginal product of labor in the timber industry falls. This is equivalent to the fall in the real wage in terms of timber. With less labor in televisions, the marginal product of labor in the television industry has risen; i.e., the real wage in terms of televisions has risen. b. What is the impact of opening trade on the rentals on capital and land in Canada? Can we predict the change in real rentals on capital and land? The rental on capital is the price of televisions times the marginal product of capital. We know that the number of workers in the television industry has fallen, so the marginal product of capital has fallen. The price of televisions has fallen as well, so the rental on capital has fallen. The fall in the MPK is equivalent to the real rental of capital in terms of televisions having fallen. Recall that the price of televisions has fallen relative to timber, which has stayed constant. Since the rental has fallen in terms of televisions, it must also have fallen in terms of timber as well. Note that since the real rental has fallen in terms of both goods, we can simply say that it has fallen. The nominal rental on land is the price of timber times the marginal product of land. The price of timber is unchanged. With more labor in timber, the marginal product of land rises. Thus the
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