Question1. This question helps you review
the Specific-factors model. 24 points, 2 each, except (3).
There are two countries, Home
and Foreign, and they produce cars and bananas. Cars are produced using capital
and labor, and bananas produced using land and labor. Under the closed-economy
equilibrium, Pcar/Pbanana > Pcar*/Pbanana*;
i.e. the relative price of cars is lower in Foreign than in Home.
(1). Draw a picture to show the
Home country’s closed-economy equilibrium.
(2). Show the Home country’s
free trade equilibrium in your picture above.
For the questions below, assume that as the Home country
moves from closed economy to free trade, the price of cars drops by 10% and the
price of bananas remains unchanged.
(3). Draw a picture to
illustrate the equilibrium in the Home country’s labor market. Then show how w,
Lcars and Lbananas change as the Home country goes from
closed economy to free trade. (4 points)
The following are T/F questions, and describe the change
in the Home country in the movement from closed economy to free trade. Please
explain why they are T/F. Hint: You may want to use your answers in (1)-(3).
(4) MPLcars increases
because labor employment in the cars industry increases.
(5) The opportunity cost of
bananas increases.
(6) The capital owners have
lower purchasing power for cars.
(7) The workers have lower
purchasing power for cars.
(8) The rental rate of land
decreases by less than 10%.
(9) The rental rate of capital
decreases by more than 10%.
(10) Wage decreases by less than
10%.
(11) Capital employment in the
cars industry decreases.
