Question

Consider the case of Thailand, a small open economy that faces constant goods prices (takes the world prices as given and has no impact on it.) Assume that there are two sectors, manufacturing and farming. There are three productive factors. Labour is employed in both sectors and is freely mobile between them. Capital is used only in manufacturing and land only in farming. After the recent floods a relevant part of arable land has been destroyed: discuss the effects on wages and the incomes of capital and land owners. Thoroughly explain your answer using figures.

Answer 1

There are three productive factors... Land, labour and capital and the registration for theses factors are in the form of rent, wage and interest respectively.... The recent flood destroyed relevant part of the arable land .. So that the production might have fallen.. In the case of labour ( they are freely mobile between two sectors) , a fall in the supply of production leads to price rise in the manufacturing sector... Due to an increase in the price level, wage also increases ( shortage of employees)  workers will supply more labour and firms demand more labourers at the existing wage rate , as a result the wage comes down...and the price also falls and reaches at its original level ..

In the case of land, flood destroyed lands availability... So the supply of land shifts to the left ( S to S1), the rent increases from R to R1. Similarly a fall in the demand for land shifts to the left and reduces the rent to R2.  

In the case of capital, a fall in the production reduces investment in the economy . Fall in income reduces consumption and savings in the economy... As a result the investment shifts to the left and rate of interest falls to r1. similarly savings reduction shifts the saving curve to the left leads the rate of interest to its original point (r)

There are two sectors... If the flood affects the farming sector, the unemployed laboureres can move to manufacturing sector... As a result the SS of labour in the manufacturing sector reduces the wage rate... At the same time, decrease in the labour supply in the farming sector raise the wage rate... Due to higher wage in the farming sector, more labour come back to faming sector from the the manufacturing sector ...this process goes on till it reaches original equilibrium point...

This is shown in the following figures