Homework #3: Specific factors (20pts)
Setup
Azerbaijan can produce two goods wheat and shirts. Labor is mobile between sectors while land is
specific to production of wheat and capital is specific to production of shirts. Azerbaijan has
comparative advantage in wheat and exports wheat .
Questions
1. Using Figure 3-4 as a guide label the following graph that represents trade equilibrium for
Azerbaijan.
PPF
World price
line
Q_w__
production
Indifference
Production
point
curve w/trade
of wheat
Consumption
point
export of
wheat
consumption
of wheat
Qsh_
__
Production
of shirts
Importing
of shirts
consumption
of shirts
2. How do you know from the picture above that Azerbaijan as a whole gains from trade?
a. The consumption point lies outside the PPF. A point like this was not achievable without
trade. The trade indifference curve is higher than an indifference curve (like the one in
red) with trade.
3. The figure below describes allocation of Labor between production of shirts and wheat. Using
figure 3-5 as a guide label the figure below (put shirts on the left).
_
𝑊𝑠𝐻
𝑀𝑃𝐿𝑤 × 𝑃𝑤
𝑀𝑃𝐿
𝑚𝑝𝑙𝑠ℎ
× 𝑃𝑃𝑠ℎ
𝑠ℎ ×
𝑠ℎ
___
𝑊𝑠ℎ = 𝑊𝑤
W
0shirts
𝐿𝑠ℎ
0wheat
𝐿𝑤𝐿
𝐿
4. On the figure below show effect of a decrease in the price of wheat. Use Figure 3-6 as a guide.
Make sure to…
a. Show the shift in the appropriate line
b. Show and label the size of the shift
c. Show reallocation of labor
𝑚𝑝𝑙𝑠ℎ × 𝑃𝑠ℎ
𝑊𝑠ℎ
__
𝑚𝑝𝑙𝑠ℎ × 𝑃𝑠ℎ
Vertical distance
= ∆𝑃𝐴 × 𝑀𝑃𝐿𝐴
W
W’
Movement
of labor
0shirts
𝐿𝑠ℎ
New Lsh
𝐿𝑤ℎ
New Lwh
0wheat
5. Compare the resulting change in wage and change in the value of marginal product. Explain why
one is greater than the other.
a. The change in wage is smaller than the change in the value of the marginal product. The
wage does not fall by as much as the MPLxW because as the wage drops and labor
leaves production of wheat the marginal product of labor increases. The law of
diminishing returns is applied in reverse in a way: less labor leads to higher marginal
product.
6. What will happen to the nominal wages and returns to capital and land?
a. Nominal wage drops because the price and thus the value of the marginal product
drops. Cheaper output combined with reduction of labor reduces returns to land
specific to the production of wheat. More labor increases returns to capital.
7. What will happen to the real wages and returns to capital and land?
a. Real wages will increase with respect to wheat since the price drops by more than wage
and the opposite is true for shirts. Prices of shirts stay the same but the nominal wage
decreases. The real rental for capital will increase because the nominal rental increases
and price of wheat falls and price of shirts does not increase. The rental on land
decreases because the decrease in rental is larger than the decrease in the price of
wheat.
8. Starting from the initial situation, the government of Azerbaijan decides to protect domestic
producers of shirts by imposing import tariff and thus increasing the price of shirts. Who gains
and who loses from such policy and why?
a. When goods are protected this increase the domestic price of shirts so rents on capital
will increase also wages will rise making buyers of wheat better off. While those
consuming shirts will be worse off and land owners rents will fall as more workers are
held in the manufacture of shirts.
9. Please solve problems: 4, 5, 10, 12
Ch. 3 Problems.
4a. Since change in W is less than the change in P *MPL in agriculture then
−∆𝑊
𝑊
≤
−∆𝑃
𝑃
. This fact is
seen by the shift in the graph being greater than the new equilibrium wage.
4b. Real wage will fall due to the fact the change in price is zero the change in wage makes the W/P
fall.
4c. The results are ambiguous since it would depend on which goods where consumed .
5a. ∆RT= (.1*150-.05*50)/100 =.125 or 12.5%
5a. ∆RK= (0*150-.05*100)/50 =-.1 or -10%
5b. Therefore the real rental rate on land increases more than the change in wage and price. This is
due the fact that the higher wage brings in greater production and the higher price also grows the
rental rate.
The rental rate on land falls as more workers move to the other side and their is no change in
price on agriculture.
10a.
This graph shows that as more labor
is added to the same amount of land
the additional amount provided by
that worker is less.
10b.
The relative price of wheat is
Pw/Pc=Mplc/mplw since wage is
mobile and the market is assumed to
be in equilibrium the wages are also
equal. This also means that the
opportunity cost of a good is equal to
the relative price of the other at any
point along the curve.
12a. To qualify the manufacture and now service industries must be impacted by import
competition.
b. The amount received is half of a projects value upto $75000.
c. The pro’s for this type of assistance is that it only helps to supplement the investment cost of
new projects for the firm meaning they most still remain efficient in order to truly benefit from the
assistance. Unlike tariffs which have no implied efficiency built into the system.
The con is that it still has to give assistance to companies that possible have higher opportunity cost
than other firms that could produce greater gains with the same assistance. Also this an after the
fact assistance and may not provide a fast enough reaction to truly help those companies in need of
assistance.