Question

In: Economics

Zimbabwe produces both food (F) and diamonds (D), where food production relies on land (T) and...

Zimbabwe produces both food (F) and diamonds (D), where food production relies on land (T) and labor (L). Diamond production requires only labor (L) and capital (K). Assume land cannot be used in diamond production and capital cannot be used in food production. Labor, however, is perfectly mobile between the two industries.

a. Illustrate the marginal product of labor for both industries on the same graph, and show the wage and quantity of labor used in both industries.

b. Suppose that the price of diamonds on the world market is higher than the autarky price of diamonds in Zimbabwe, and further suppose that the price of food is the same in autarky as it is in free trade. Show using your graph in part a how Zimbabwe’s moving from autarky to free trade affects the value of the marginal product of labor and thus the allocation of labor across sectors.

c. Explain how the movement to free trade affects the returns to capital and the returns to land in Zimbabwe.

d. In general, what does the specific factors model predict about which factors will favor free trade, and which factors will oppose free trade?

Expert Solution

a. The given problem is the case of specific factors model.

The Industry specific factors are as follows :

Diamond production requires Labor(Ld) and Capital (K).

Food production requires Labor (Lf) and Land (T).

Capital and Land are immobile factors of production. And Labor is the mobile factor of production which can move between industries and countries.

The above figure shows the marginal product of labor of food (MPLf) and marginal product of labor of diamond industry (MPLd). W* is the equilibrium wages in both the industries where the labor would be stable and satisfied. L* shows the units of labor in the equilibrium situation.

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b.

When Zimbawe shifts from autarky to free trade, the prices of diamond in world are higher than that in the autarky and the prices of food are equal in both autarky and free trde.

When the prices of diamond in Zimbawe would increase due to free trade, it would lead to raise in the wages of labor in diamond industry. And the wages in food industry would be the same but lesser than those in diamond industry with the shift to free trade. Hence, labor from food industry would move to diamond industry to have better lives and satisfaction leading to the movement of equilibrium in labor market from E* to E1. The labor in diamond industry would increase from L* to L1 and labor in food industry would decrease from L*to L1. In long run, the food industry wages will increase too to be in the situation of equilibrium and stop the migration of labor.

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c.

In diamond market, the prices of diamond increases with the shift from autarky to free trade leading to increase in wage rates and the rental income of the capital owners.

Rental income of Capital owners = MPKd . Pd

With price increasing, rental income of capital owners increase.

Now, as seen in the food industry, labor moves to diamond industry leading to fall in the MPL leading to fall in production activities. This in turn will lead the land owners to loose part of their incomes rendering them worse off. And in long they will have to increase the wages of labor to produce more but the income of land owners would not be increasing.

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d.

The losses that the owners of factors of production will have to bear, will be an opposing factor for free trade. Moreover, if with free trade the prices of a good is increasing, it would lead to a fall in the demand of that good as consumers will have to pay more to acquire one unit of the good that they used to consume at lesser prices in other case.

The labor who will be earning more wages in the industry would be better off and even the capital owners in the industry will be better off giving a reason to enter into free trade.

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Rahul Sunny answered 2 years ago

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