Consider the specific factors model we learned in class. Suppose two countries i
ID: 1188886 • Letter: C
Question
Consider the specific factors model we learned in class. Suppose two countries initially have the same supply of labor, capital, and land. Then suddenly the capital stock in Home has doubled.
(a) Show how the increase in the supply of capital for Home affects its production possibility frontier.
(b) On the same graph, draw the relative supply curve for both Home and Foreign.
(c) If those two economies open up to trade, what will be the pattern of trade?
(d) Describe how opening up to trade affects all three factors (labor, capital, land) in both
Explanation / Answer
Sorry sould not upload the graph, however will help you with the answers.
Ans a. the increase in the capital stock in Home will increase the possible production of good 1, but have no effect on the production of good 2, since good 2 does not use capital in production. As a result, the PPF shifts out to the right, representing the greater quantity of good 1 that Home can now produce.
Ans b. Given the increased production possibility for Home, the relative supply of home (definedasQ1/Q2) is further to the right than the relative supply for Foreign. As a result, the relative price of good 1 is lower in Home than it is in Foreign.
Ans c. If both countries open to trade, Home will export good 1 and Foreign will export good 2.
Ans d. Owners of capital in Home and owners of land in Foreign will benefit from trade, while owners of land in Home and owners of capital in Foreign will be hurt. The effects on labor will be ambiguous since the real wage in terms of good 1 will fall (rise) in Home(Foreign) and the real wage in terms of good 2 will rise (fall) in Home (Foreign). The net welfare effect for labor will depend on preferences in each country. For example, if labor in Home consumes relatively more of good 2, they will gain from trade. If labor in Home consumes relatively more of good 1, they will lose from trade.