Reference no: EM13855499
Suppose the home country exports clothing, which is produced by labour and capital, and imports food, which is produced locally by labour and land. That is, assume the specific-factor production structure of Chapter 4. Let some of the capital used in the clothing sector be provided by foreign investment. If the home country protects its food industry with a tariff, trace through the following scenarios:
a. What is the effect on factor prices, production, consumption, and trade volumes if no more foreign capital enters or leaves the country?
b. What is the further impact on factor prices, production, consumption, and trade if returns to capital in the clothing sector adjust to a given world rate of return via changes in the quantity of capital (FDI) foreigners wish to place in the protectionist country?
c. What is the effect on net home welfare in each case?
IV. Income Distribution (20 marks)
Consider the following pre-trade data for Home in a Heckscher-Ohlin model with two goods (wine and cheese) and two factors (capital and Labour).
aKC = 5 hours per kg (unit of capital requirement in cheese)
aKW = 10 hours per litre (unit of capital requirement in wine)
aLC = 15 hours per kg (unit of labour requirement in cheese)
aLW = 20 hours per litre (unit of labour requirement in wine)
PC = $80 (price of cheese)
PW = $110 (price of wine)
a. Solve for equilibrium pre-trade wage and rental rate, remembering that due to the perfect competition problem and zero economic profit, P= MC, or P = aK . r + aL .w, in each sector, where aK and aL are capital and labour requirement in their respective sector, and w and r represent the cost of labour and capital per hour.
b. Now suppose that a comparison with the rest of the world has revealed that Home has a comparative disadvantage in cheese so that when trade starts the price of cheese in Home falls from $80 to $75. Solve for the post -trade equilibrium wage and rental rates.
c. What has been the impact of trade on the real return to the factors of production? Does your answer corroborate the Stolper- Samuleson theorem? Why?
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