Question

Consider the specific factors model. In the country Youland, two goods are produced: degrees (d) and fun (f). Both goods are produced using a combination of labour and a specific factor for each good. The specific factor for degrees is ability (a) while the specific factor for fun is games (g). Both goods are produced with diminishing returns, as is standard.

1. Explain why, in equilibrium, the absolute value of the slope of the PPF must equal the relative price of degrees. Assume that, in the PPF, degrees goes on the x-axis while fun goes on the y-axis. (hint: first show what the absolute value of the slope of the PPF must equal, and then show why that value must equal the relative price).
2. Suppose that Youland receives a large amount of extra ability. Use a well-labelled “scissors” diagram to help explain how this extra ability will affect the allocation of labour across degrees and gamesfun, as well as nominal wages in Youland. Assume that output prices don’t change.
3. Return to Youland’s original allocation of ability and games (i.e. ignore the additional ability added in part b)). Now suppose that Youland becomes more productive in producing fun. Specifically, at each point on the production function, Youland can now produce 20% more fun than it could before (hint: think about how a percentage increase in output prices translates to the value of marginal product curves; this will help you think about how the marginal product of labour is affected). Assume that output prices remain constant. How does this affect: 1) Youland’s MPL curve for gamesfun, 2) its labour allocation between degrees and fun, 3) how labour is affected, and 4) how ability and games owners are affected. Draw: 1) an MPL curve for games to demonstrate how MPL for games fun is affected, 2) a labour allocation diagram, and 3) MPL curves for both goods to demonstrate how ability and games owners are affected. Explain your reasoning and any curve shifts in words, in addition to drawing the diagrams.
4. focus again on Youland’s original allocation of ability and games. Suppose that Youland opens up to trade with another country, Themada, that has a larger amount of games (relative to its ability endowment) compared to Youland. Assuming that Themada and Youland are the only two countries in the world, answer the following: 1) how is the relative price of degrees affected by opening up to trade, 2) how is this reflected in the labour allocation (scissors) diagram, 3) how is labour allocation between the sectors, nominal, and real wages affected, and 4) how are ability and fungames owners affected. Please draw at least: 1) the labour allocation diagram, as well as the corresponding shifts in the curves within that diagram, 2) the RS-RD curve diagram to show how relative prices are affected by trade, and 3) at least one MPL diagram to show how either ability or fun games owners are affected, to answer the question.

Answer 1