2009 - fall - midterm - solutions

A lc a lf p c p f rs q c q c q f q f rs la lc l a lf

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intercepts and slopes. a LC /a LF P C /P F RS Q C +Q * C Q F +Q * F RS ^ L/a LC L * /a * LF L ^ /a LC L * /a * LW a* LC /a* LF (c) Now suppose that the Speci²c Factors model applies: Capital (K) is speci²c to the production of Cloth, Land (T) is speci²c to the production of Food and Labour (L) is freely mobile and required for the production of both goods. If Home±s Labour force increases from L to ^ L; use a graph to show what happens to the Home wage and employment in both industries when P C and P F do not change. 3
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Explain what will happen to the earnings/returns to all 3 factors, Labour, Capital, and Land. w C =w F P C MP LC L C L F L F ^ L C ^ P F MP LF w ^ C = w ^ F With the increase in Labour there will be a reduction in the wage in both in- dustries. With a lower wage there will be more workers hired in both industries so labour should increase in both Food and Cloth. Real wages will decrease (more workers lowers the marginal productivity of labour) and the real income of both Capital and Land-owners will increase (more workers raises the marginal productivity of both land used in Food production and Capital used in Cloth production). (d) Now suppose the Heckscher-Ohlin model applies: Labour (L) is used intensively in the production of Cloth, Land (T) is used intensively in the production of Food. Home exports cloth. Explain how an increase in Home±s Labour force (from L to ^ L ) will impact the Terms of Trade for the Home country and use a graph of Home±s production possibilities frontier to show how this will a/ect the welfare in the Home country. The increase in labour will lead to Cloth (export) biased growth. The RS of cloth shifts right and the terms of trade deteriorate. Welfare may increase or decrease. If welfare decreases this will be an example of immiserizing growth. See lecture notes for ²gure. PART C: 1. Read the following excerpt from an article that recently appeared in the Globe and Mail (October 21, 2009). 4
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(a) The basic Ricardian and Heckscher-Ohlin models assume that there are no trans- port costs required to export and import goods. What are the predictions of both of these models with regards to the prices of factors of production across countries with free-trade (wages in the Ricardian model, or the wage-rental ratio in the H.O. model)? Are the predictions regarding factor prices for either or both models supported by empirical evidence?
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