Answer to Question #265862 in Economics for Happy

Question

The Specific Factors Model (Lecture 3)

We examined a trade liberalization shock for the specific factors model during the lecture. Now instead consider the following shocks for a closed economy (to simplify the analysis, let's assume that Pc and PF are fixed and do not respond to the shocks):

(a) An exogenous increase in the labour specific to the sector producing food (LF). How does it affect the equilibrium outcomes (wages, rental rate of capital, the allocation of capital across sectors)? Who are the winners and losers from this shock?

(b) How about an exogenous increase in the total amount of the mobile factor K? Who are the winners and losers?

(Hint: How does each shock affect the figure we use to analyse the equilibrium?)

Answer 1

(a) An exogenous increase in the labour specific to the sector producing food will decrease equilibrium wages, decrease rental rate of capital and improve the allocation of capital across sectors. The winners are producers and consumers, and the losers from this shock are employees.

(b) An exogenous increase in the total amount of the mobile factor K will also decrease the production costs so producers and consumers are the winners and the employees may be losers, as the demand for labour will decrease.