Question

In: Economics

Two countries, Spain and Portugal, use two inputs, capital and labor, to produce two goods, wine...

Two countries, Spain and Portugal, use two inputs, capital and labor, to produce two goods, wine and cheese. Wine is relatively capital intensive in production and Spain is the relatively capital abundant country.

4) According to the Factor Price Equalization Theorem wages (earnings from labor) and rent (earnings from capital) between Spain and Portugal will equalize:

Question 4 options:

with migration of labor and free international movement of capital.

solely due to labor migration.

solely due to the free international movement of capital.

due to both free trade in final goods and free movement of the factors.

due to free trade in final goods alone.

Solutions

Expert Solution

If wine is relatively capital intensive in production and Spain is the relatively capital abundant country, Spain will specialize in production of wine and export a part of the production for cheese (produced by Portugal).

This is based on the argument that the labour-abundant country specialises in the export of the labour-intensive commodity because labour is a relatively cheaper factor compared with capital. On the other hand, the capital-abundant country specialises in the export of capital-intensive commodity on account of capital being a relatively cheaper factor there.

The export of wine by Spain creates relative scarcity of capital and consequently price of capital rises. On the opposite, the export of labor- intensive commodity (cheese) by Portugal will result in its scarcity there. It will cause a rise in the price of labor (wages). These relative changes in K-L ratio will continue until the K-L ratios in both the countries become exactly equal. Along with it, the prices of the two factors also undergo changes (rise in interest rate in Spain and rise in wage rate in Portugal) in such a manner that there is ultimate equalisation of prices of two factors in both the countries.

Thus,  According to the Factor Price Equalization Theorem wages (earnings from labor) and rent (earnings from capital) between Spain and Portugal will equalize: (d)due to free trade in final goods alone.

Rahul Sunny answered 8 months ago
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