Question

Two countries, Home (H) and Foreign (F) trade agricultural and manufacturing goods (A and M, respectively). Production of either good requires skilled and unskilled labor. Unskilled workers can freely move from one sector to another, while skilled workers cannot.

(a) 5% Identify mobile and industry-specific factors of production

(b) 5% Suppose Home is relatively more productive in agriculture than Foreign. Draw two diagrams, one for H one for F, which illustrate no-trade equilibrium in each county. Compare relative price of agricultural goods in two countries.

(c) 5% Based on your answer in part (b), explain which good Home country will export and import, and why? Explain how openness to foreign trade changes relative price of agricultural goods at Home.

(d) 5% Using a diagram, illustrate the effect of a reduction in price of Home country imports on Home countrys equilibrium nominal wage.

Answer 1

Answer (a) : Factors of production are those variables which affect the production function of a firm. These are usually the critical embodiments which constitute the manufacturing capability of a unit or firm. Such factors of production usually constitute the land, capital & labor which are critical to the production. In this case mentioned here, the unskilled labor or workers of both the home and foreign countries are the mobile factors of production, as they can freely move or travel from one sector of production to another sector. The factors of production which are industry specific or immobile are the skilled labor or workers, land, capital.

                              Answer (b) :

                                           As shown in Figure (i) above, The Home country has Manufacturing measure in the X axed and Agriculture measured in the Y axis. Since the Home country is more efficient in producing agricultural products as compared to the Manufacturing products, we can see that the agricultural output OF is much greater is comparison to the Manufacturing Output OM. The equilibrium in the country will be achieved at the point E1 which will also determine the price of agriculture in the Home country in comparison to its manufacturing produces.

                                            

As shown in Figure (ii) above , The Foreign country has Manufacturing measure in the X axed and Agriculture measured in the Y axis. Since the Foreign country does not have any distinction in the producers of either agriculture or manufacturing products, agricultural output OA and the Manufacturing Output OM are representing an equivalent degree. The equilibrium in the country will be achieved at the point E2 which will also determine the price of agriculture in the Foreign country in comparison to its manufacturing produces.

  The relative price of agriculture in the Home country will be much lesser as compared to the price of agriculture in the foreign country, since the greater produce of the agricultural produce will satisfy the demand of the consumers in the market and thereby bring down the price of the agricultural products.

Answer( c) : The Home country will be ready to export both the products Agriculture and Manufacturing, however, the home country will be more inducive to export the agricultural products since it has a greater intensity in the production of agricultural products. It will be ready to import manufacturing products depending on the exclusive requirement, however, it would not want to import agricultural products since it has excessive agricultural products in its own land.

                            The Foreign country on the other hand will be ready to export both the products Agriculture and Manufacturing. It will also be ready to import both manufacturing products and agricultural products at the same degree.

                            The openness to trade will help both the countries to control the relative price because, when trade is open, both home and foreign countries trade the products according to their own requirements, and not depend on the other exporting or importing nation. Openness to trade indicates the scenario where the price of a product in a country is directly impacted when the export or import of the product changes its dimension of availability in the country.