(1). Which theorem states that free trade leads to an equalization of wages and rental rates...

(1). Which theorem states that free trade leads to an equalization of wages and rental rates in two trading countries? Explain How and Why wages and rental rates ultimately equalize.

(2) What happens to the production of both goods in a country when there is an increase in labor? Which theorem will you apply here?

Give diagrams to show this and explain clearly

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Expert Solution

(1) Factor price equalization theorem states that free trade leads to an equalization of wages and rental rates in two trading countries. The theorem states that as the prices of the commodities in two trading countries equalize, then the price of factors such as labour and capital also equalize. This also implies that the wages and rental rates also equalize in both the trading countries.

In a market, the productivity depends on the marginal rate of productivity which depends on the number of labours and capital used. The marginal productivity of a factor and the amount of labour or capital is inversely related, as a result of which the marginal productivity falls as labour increase. Likewise the value of productivity depends upon its price and once a country is allowed to trade freely with another country, the output prices become equal. As a result of which, the factor prices, wage and rental rates also equalize in both the nations. Thus, they end up having same labour-capital ratio as well.

Rahul Sunny answered 1 year ago

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