Question

International econ V. specific factor model The country of Riclo produces two products: Cloth and Rice. Cloth requires both Capital and Labor to produce. Rice requires both Land and Labor to produce. Riclo has perfectly competitive markets for Labor, Cloth and Rice. Riclo has 100 units of Capital, and all the Capital is used for Cloth production. Riclo has 200 units of Land, and all the Land is used for Rice production. Riclo has 1000 units of Labor, and each worker can work equally well in either Cloth or Rice production; therefore each worker will work in whichever industry pays higher wages. Since all Capital is allocated to Cloth and all Land is allocated to Rice, the production functions for each industry only depend on the quantity of Labor dedicated to that industry. The production function for Cloth is QC=20LC This means that the Marginal Product of Labor in Cloth is MPLC=10LC The production function for Rice is QR=50LR This means that the Marginal Product of Labor in Rice is MPLR=25LR You can take our word for it that these Marginal Products are correct. You do not need to use calculus to verify the equations. In Autarky the Price of Cloth is $10 and the Price of Rice is $12. You do not need to be mathematically precise on your graphs as long as the general shapes and slopes are correct. You do need to label your axes correctly. You also need to label all important points on the graph with numbers on the axes. You should draw a dotted line from the point on the graph to the number on the axis. Round all quantities to the nearest whole number, including quantities of Labor. Round all prices, wages and returns to two decimal places. Relative Prices, Relative Quantities and Slopes can be left as fractions, or they can be expressed as decimals rounded to two decimal places. Now, assume that Riclo starts to trade with the rest of the world. Assume that Relative Demand remains unchanged (that is, the World Relative Demand Curve for Cloth and Rice is the same as the Riclo Domestic Relative Demand Curve for Cloth and Rice). But the World Relative Supply Curve is different from the Riclo Relative Supply Curve, and results in a higher Relative Price of Cloth. With Free Trade, the new Price of Cloth is $20 and the Price of Rice remains at $12. Assume Free Trade for all parts of this question. Show your work for all parts of this question. Do not just write down a number. The problem continues on the next page. Calculate the quantity of Labor used in each industry in Riclo. Calculate the Quantity produced in Riclo in each industry. Calculate the equilibrium Nominal Wage in Riclo. Explain in general terms the conditions under which workers in Riclo might be better off due to Free Trade and the conditions under which the workers in Riclo might be worse off due to Free Trade. Calculate the Return to each unit of Capital in Riclo under Free Trade. Are owners of Capital in Riclo better off or worse off with Free Trade compared to Autarky?

Answer 1

Given is the country of Riclo which poduces Cloth and Rice using both Capital and Labor to produce. Rice requires both Land and Labor to produce. Riclo has perfectly competitive markets for Labor, Cloth and Rice. We are also given that Riclo has 100 units of Capital, and all the Capital is used for Cloth production. Riclo has 200 units of Land, and all the Land is used for Rice production. Riclo has 1000 units of Labor, and each worker can work equally well in either Cloth or Rice production. The production function for Cloth is QC=20LC & the Marginal Product of Labor in Cloth is MPLC=10LC The production function for Rice is QR=50LR & the Marginal Product of Labor in Rice is MPLR=25LR. In Autarky the Price of Cloth is $10 and the Price of Rice is $12.
With Free Trade, the new Price of Cloth is $20 and the Price of Rice remains at $12. Therefore, Riclo will use 10*LC = 20*100 thus, LC = 200, MPLR = 12 so 25LR = 12*200 thus LR = 96 Thus QC = 20*200 = 4000 of coth and QR = 50*96 = 4800 of rice. The equilibrium wage will be MPRC*Price of rice in free trade 25*12 and 20*10 thus there average is $250 so it will be equilibrium wage. Workers in Riclo will be better of when price of rice rises and price of cloth remain same as their marginal product is better in production of rise. Workers in Riclo will be worse off if price of cloth rise. Because under autoarcy the return to cloth rises a it production rises the owner of capital area better off in free trade than autarky.