In: Economics
Ashland is considering whether to engage in international trade in rice and furniture. The world price of rice is lower than Ashland’s “no-trade” price, but its “no-trade” furniture price is lower than the world price. Assume land is specific to rice, capital is used mainly in furniture making and labor is mobile across sectors. In Ashland, who will be in favor of trade? Who will be opposed? Explain briefly. Show on a graph what happens in the labor market.
The world price of rice is lower than domestic no-trade price, and its no-trade furniture price is lower than the world price. Now if the nation starts trading it will be exporting furniture so the factors of production engaged in its production will gain. Since land is specific to rice and capital is used in furniture, capital owners will find their incomes increasing. With higher capital rents, it is likely that capital owners will not oppose the trade. Production of furniture is increased and this increases the demand for labor.
Relative to the price of furniture, the price of rice will fall so that landowners will find the rental price of land falling as production is reduced. Production of rice is decreased and this decreases the demand for labor.
Hence in the labor market there will be a switch of labors from rice market to furniture market as their wage rate falls in rice market and rises in furniture market. Final effect on wage rate is ambiguous because the movement of labor from one market to the other also reduces the supply so that the final wage in equilibrium is more or less same as the initial equilibrium