Question

Answer as many of the following as you can:

Suppose two countries, Canada and Mexico, produce two goods: timber and avocados. Assume that land is specific to timber, labor is specific to avocados, and capital is free to move between the two industries. Assume further that when Canada and Mexico engage in free trade, the relative price of avocados in terms of timber increases in Mexico and falls in Canada.

(a)

i. In a graph for the Mexican market for capital (the mobile factor), show and ex- plain step-by-step how the (nominal) rental on capital changes in Mexico due to an increase in the price of avocados, holding constant the price of timber.

ii. What happens to the real rental of capital, i.e., are capital owners better off or worse off in terms of their purchasing power? Explain briefly.

(b) What is the impact of opening trade on the nominal and real wage in Mexico? Are workers better or worse off in terms of their purchasing power? Illustrate and explain briefly.

(c) What is the impact of opening trade on the nominal and real rental on land in Mexico? Are land owners better or worse off in terms of their purchasing power? Illustrate and explain briefly.

(d)From the information given in the question above, determine Mexico’s export industry. Explain briefly how you reached this conclusion.

(e) i. What is the specific factor in Mexico’s export industry? ii. What is the specific factor in Mexico’s import industry? Explain briefly.

Answer 1

a) i) For the Mexican market on capital which is a mobile factor,we will see the impact that trade has on the rental price of capital. In a situation of trade between Mexico and canada, relative price of avocados in terms of timber increases in Mexico and falls in Canada. This means that trade increases the price of avocados in Mexico. Holding constant the price of timber, when the price of avocados increases, the relative price of avocados increases as well. Timber becomes cheaper in comparison. Now considering the impact on the nominal rate of return on capital, it increases as well.

ii) In terms of the real rental rate of capital, it becomes quite a paradox given the situation that while the nominal rate of return increases, with an increase in the price of avocados, the real rate of return of capital actually falls, The purchasing power of the capital owners decreases which makes them worse offr.

b) Opening trade doesn't seem very beneficial for Mexico, although with an increase in the price of avocados the nominal rate of return on capital increases but the real return measured in terms of the purchasing power of the capital owners falls. Labour is the specific factor to Mexico, therefore an increase in the relative price of avocados benefits wage earners. the Nominal wage increases and so do the real wage. The workers are better off in terms of their purchasing power.

c) Land is the specific factor to Canada in the production of timber so opening of trade in context to Mexico doesn't benefit the return on land in Mexico.Land owners are worse off in their purchasing power.

e)i) The specific factor in Mexico's export industry is labour , Mexico specialises in avocados production which is labour intensive.

ii) The specific factor in Mexico's import industry is land, Canada exports timber to Mexico which is land intensive.