4. Consider the specific (or fixed) factors model of trade. In sector A (for agr
ID: 1109329 • Letter: 4
Question
4. Consider the specific (or fixed) factors model of trade. In sector A (for agriculture) nufacturing) capital is the fixed factor. Both sectors use labor which is free to move between sectors A and M within the same country boundaries. Take the domestic country to be too small to change world prices. a) If foreign direct investment (FDI) brings capital from abroad and adds to the capital stock of the domestic manufacturing sector, what happens to the allocation of labor between the two sectors? What impact would this FDI have on real wages, the returm to land and the return to capital? b) Suppose there are capital controls which effectively prevent movement of capital between countries, but labor is permitted to enter the country enlarging the stock of labor through immigration. What does immigration do to the allocation of labor between the two sectors? What impact would this immigration have on real wages, the return to land and (stuck in agriculture) and the return to capital (which is stuck in manufacturing)?Explanation / Answer
Answer:
A) There will be a transfer of labor from Agriculture sector to the Manufacturing sector.Due to the wage premium in the manufacturing sector and due to the increasing demand from the manufacturing sector. therefore according to H-O theorem, the endowment in manufacturing sector i,e dQ/dL will improve than the dQ/dK.
Therefore, the real wages in the manufacturing sector will increase and that of the agricultural sector will fall. the return to the land and capital will remain fixed due to the proximation they have been used in the model i,e exogenous.
B) Now if the labor is moving between countries keeping capital stock county specific the immigration will lead to increase the endowment of labor into the labor-intensive sector which is agriculture.
Therefore, the wages in the agricultural sector will fall whereas due to the fixed capital cost. the labor endowment in the manufacturing sector will depend on the demand which may or may not change the wage structure. the return to land and capital stock will remain unchanged.
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