Question

4. Consider an instance of the Specific Factors model with two goods – Agricultural goods (A) and Manufactured goods (M) – and three productive factors – Labour (L), Capital (C) and Land (T). What are the assumptions of the Specific Factors model? What are the gains and losses of trade within the Specific Factor model? Provide graphs and formulas if possible.  

Answer 1

Assupmtions of Specific Factor model:

a.This model assumes that an economy has only two production goods which are produced with the help of 3 factors: Capital, land and labor.

b.Capital used in one industry, land used in other industry , these are specific factors

b.Third factor labor is mobile.

c.The market is perfectly competitive.

e.In each of the industry, increases in the no. of labor are dependent on diminishing return. Marginal product of labor reduces as labor use increases in the industry.

Formula: companies in the industry employ labor till the point where cost of one more hr of labor(wage) equals to the value of one more hr of labor in production process:

W= P * MPL where W=wage, P=Production, MPL=marginal productivity of labor

f. two countries are there

Gains of trade within the Specific Factor model?:

i. goods are exported for whom relative price go up.

ii. goods are imported for whom whose relative price comes down.

iii. export at higher price and import are lower price(based on relative price mechanism), country will perform better than what had been done without trade.

Losses of trade within specific factor model:

i)Landowners would be at loss.

ii)Increase in the labor amount minimizes marginal product for both manufacturing and agriculture sector.

iii)Each country has to face production possibilities forntier issue.

The uploaded picture depicts production function for manufactures. X-axis represents Labor input, L_M.

Y axis represents Output, Q_M and curve shows production function Q_M is factor of Labor and Capital.