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

5) According to the Rybczynski Theorem, if Portugal were a small country with a free trade policy, growth of the labor force would cause:

Question 5 options:

	wages to fall, and the reward to capital to increase in Portugal.
	expansion of the cheese industry and contraction of the wine industry in Portugal.
	expansion of the wine industry and contraction of the cheese industry in Portugal.
	expansion of the cheese industry and expansion of the wine industry in Portugal.
	contraction of both the wine and cheese industries in Portugal.

Solutions

Expert Solution

The Rybczynski Theorem says that if the endowment of some resource increases, the industry that uses that resource most intensively will increase its output while the other industry will decrease its output. The relative factor intensity is measured by the ratio of factor use in each industry.

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). Thus Portugal is assumed to be labor abundant nation and cheese is assumed to be a labor intensive commodity.

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.

As output of cheese will expand in Portugal due to free trade policy, the demand for labor will increase. However, the production of more cheese will also lead to an increase in the demand for capital. If more capital is not used with more labor, the productivity of capital is bound to fall. As a result there will be shortage of capital in Portugal's capital intensive industry (that is, wine industry). In a nutshell, growth of labor intensive cheese industry will lead to fall in output of the wine industry in Portugal.

The correct answer is: (a)expansion of the cheese industry and contraction of the wine industry in Portugal.

Rahul Sunny answered 1 week ago

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