Question

Consider an economy with two sectors: agriculture and production of computers. There are two factors used in the production of both industries: labor, mobile between the industries, land specific to agricultural production and capital specific to the production of computers. This economy is involved in international trade and workers spend most of their earnings on computers. Now assume that the world price of agricultural products increases and the price of computers does not change, then

A.Both nominal and real wages of workers will fall

B.Nominal wage of workers will fall, real wage will rise

C.Nominal wage of workers will fall, real wage will fall

D.Both nominal and real wages of workers will rise

Consider an economy with two sectors: agriculture and production of computers. There are two factors used in the production of both industries: labor, mobile between the industries, land specific to agricultural production and capital specific to the production of computers. The discovery of a new fertilizer increased the productivity of workers in the agricultural industry by 15%. What happened with the real wage of workers?

A.The effect is ambiguous - it depends on workers' consumption basket

B.It decreased

C.Nominal wage increased, real wage did not change

D.It increased

Answer 1

In the above image I have shown diagrmatically what will happen when prices of agriculture products increase and price of computers don't.

The equilibrium distribution of labors between two industries where the value of marginal product of labors is equal. In the above diagram the initial equilibrium distribution of labors is at point A where LA labors are employed in agriculture and LC are employed in computer production and equilibrium wage is at W.

When prices of agriculture product increases by 15% the labor demand curve for agriculture product shifts to the right and the new equilibrium is at point B where the new equilibrium wage is at W'. One interesting thing about the above diagram is the equilibrium wage doesn't increase as much as prices. If the wages increases equal to the increase in prices of agriculture product the equilibrium would have been at point C where equilibrium wage is at W''.

The increases in equilibrium wage is less than increase in the prices of agriculture product. And we know workers spend most of their earnings on computers whose prices have not changed.

So the nominal wage increases and real wage in term of computer increase on which workers spend their most of their earnings. Which means real wage in terms of computers rises while real wage in terms of agricultural products falls. But the real wages of worker is decided by product they spend most of their earnings on.

So the correct option will be nominal wages rise and real wages also rises. Which is option D.

Question 2.

When productivity of workers in agricultural products increases by 15% the labor demand of agriculture product in this case again will shift rightwards but in this case prices will not rise but MPLA will rise and everything else will remain the same.

Note :In this question the digram from first question can used in which everything will remain same but the now the change will be in MPLA not in PA. The new marginal product of labor in agriculture will be MPLA' and everything will remain same.

So we know the new equilibrium will be at point B where the value of new marginal product of labor in agriculture equal the value of marginal product of labor in computer production.

And nominal wages rises to W' and prices of agricultural products and computers remains the same. Hence we can confidently say that the real wages of workers has increased.

The correct option will be option D.