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Problem: Consider an economy with two sectors: manufacturing and IT services. Skilled labor is specific to IT services, and unskilled labor is specific to producing manufacturing. Also, both manufacturing and IT services require the use of capital. Assume perfectly competitive factor and product markets. Suppose that, under free trade, the economy exports IT services and imports manufacturing and, as a result, the relative price of manufacturing declines.
Required:
Question 1: What is the effect of the decrease in the price of manufacturing (while holding the price of IT services constant) on the real wages of unskilled workers? Explain
Question 2: What is the effect of the decrease in the price of manufacturing (while holding the price of IT services constant) on real wages of skilled workers? Explain
Question 3: Illustrate graphically how trade affects nominal returns of capital owners as the price of manufacturing declines (holding the price of IT services constant)
Question 4: What is the effect of trade on the real return of capital owners?
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