Question

a) Assume cloth sector C is relatively more labor intensive (relative to food sector F). Show that C firms always devote a higher share of their total cost to labor and F firms always devote a higher share of their total cost to capital.

b) In as much detail as possible, compare and contrast the specific factors model with the Ricardian model.

c) Consider the transition from autarky to trade for a country with a comparative advantage in F. No credit will be granted for unjustified answers.

1. Is the terms of trade greater than, less than, or equal to the autarky price?

2. Are workers better off or worse off?

3. Are capital owners inCbetter off or worse off?

4. Are capital owners inFbetter off or worse off?

Answer 1

Using comparative cost advantage theory, the comparatively less competitive product will be imported by one country and export comparatively advantaged products. Here there is higher preference to lower relative marginal cost prior to trade. The comparative advantage country will produce the products which have lower relative opportunity cost or autarky price.

Firms produce cloth is labour intensive and firm produce food is capital intensive. From the figure we show that the cost for labour in cloth market is higher and the cost of capital in food market is higher than the other market.
b) Specific factor model shows that one factor of production is specific. This specific factor is immobile and constant for one specific firm. At the same time it is immobile in nature. This model demonstrate the effects of trade in which one specific factors of production is specific to an industry. The model assumes firms a select an output level maximise the profit with given wages and prices. The value of marginal product is increment of revenue that firms to the production process. This model shows economic change on allocation of labour allocation, output level, factor returns etc.
Ricardian model is the case of free trade which based on comparative advantage. If a country having absolute advantage over other it is more efficient to at producing both goods than other. There is a consideration over relative opportunity cost. The country will export the goods which having comparative advantage than the other goods. The factors are mobile in this model and at the same time there are free transportation costs.  
c) 1. The autarky price is equal to the opportunity cost of producing cloth. Here the autarky price is equal to the terms of trade.
2. The workers will be better off. Because cloth is a labour intensive product and rising demand will be increased. This will improve the working condition of the people. Thus the living standard of the people also increased. Because cloth having comparative advantage over the production of cloth.  
3. The capital owners of cloth are worse off. Because labour intensive techniques are mostly used in the economy. So the demand for capital goods falls down.
4. The capital owners of food are better off, because food is capital intensive product. The demand for this goods will be increased.