International Econ

Questions 1 :

Specific Factors Model:

Specific factors model assumes that there are two goods being produced with 3 factors of production: labor, land and capital. Labor is a mobile factor from different industries, where as capital and land are specific in their own. This is considered to be a short run model. The model predicts that a change in relative price will lead to real gains one factor, losses for the other, and an ambiguous real change in the real wage for labour.

For example, consider an economy that produces two goods, X and Y, and the price of X increases relative to the price of Y, that is PX/PY increases. As PX increases, the wage rate will also increase, but it will increase proportionately less than the increase in the price of X. If that wage rate had risen by the same proportion, then there would be no change in relative price. As PX increases relative to PY labour will shift away from the Y sector and into the X sector, decreasing output of Y and increasing output of X. This is why the wage rate does not rise the same as the rise in the price of X. Because employment in X rises, the marginal product of labour in that sector falls and workers are paid their marginal product of labour in competitive markets.

Looking at the change in the distribution of income that occurs as a result, workers will find that their wage has risen, but less than in proportion to the rise in the price of X. Therefore their real wage in terms of X falls, and their real wage in terms of Y has risen. The effects on workers are ambiguous in the fact that if they prefer to buy X they are worse off, but if they prefer to buy Y then they are better off. Thus the impact on workers is dependent of their preferences, following a change in real price either way. Owners of the specific factor used in the X sector are better off because the price they charge PX has increased more than the increase in the wages they pay out. This means their profits increase. On the...