Given that: Demand for labor, DDL = f ( P, w ) Wage, w = P * MPL where P = Price

Question

Given that:

Demand for labor, DDL = f (P, w)

Wage, w = P * MPL

where P = Price of a good

         MPL = Marginal Productivity of Labor

Suppose Home economy produces 2 goods, Food and Cloth, using labor, land, and capital. Land is specific to the Food sector and capital is specific to the Cloth sector. Labor is the mobile factor implying that labor and land are used to produce Food; labor and capital are used to produce Cloth.

If the price of Food, PF, increases by 8% but the price of Cloth, PC, remains unchanged, what is the effect on the incomes of the following groups in the Home economy:

(1) Workers [Be sure to include the concepts of nominal and real wages in your explanation] [2 points]

(2) Capitalists [Base your answer on capitalists’ profits, the real wages they pay their workers, and purchasing power for food] [2 points]

(3) Landowners [Base your answer on Landowners’ profits, the real wages they pay their workers, and purchasing power for food] [2 points]

(4) Use a table to summarize your answers from parts (1), (2), and (3). Who are better off with the price change? Who are worse off? [2 points]

Explanation / Answer

In this problem, home economy is producing two goods. They are food and cloth. Three factors are used in their production. They are Land, labor and capital. Land is used only in food production. Capital is used in the production of cloth. But labor is used in both food and cloth production. Now price of food has increased by 8%. But price of cloth has not changed. Based on these points you have to show the impact of this change on income of factor supplier.

4. Finally consider the table below, where impact as discussed are summarised

Factor owner Money income Real income Impact Labor Increase Decrease Likely to be better off Capitalist No change Decrease Worse off Land owner Increase Decrease Likely to be better off

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