Question

ASAP DUE AT MIDNIGHT

1. Consider a small open economy whose relative prices are determined externally in the international market. The economy has two sectors - cloth and food. Each sector employs capital and labor and its production function exhibits constant returns to scale and diminishing marginal product. Capital and labor are mobile across industries within the economy. Suppose that there is a unique relative input price corresponding a relative output price and that both goods are produced. All markets are competitive.

(a) Define the term that Clothing industry is labor intensive.

(b) Assume that the food industry is capital intensive and the cloth industry is labor intensive. Suppose there is an increase in the supply of capital (for example, from investment from foreign firms in the above economy. There is no change in the labor supply. If the economy still produces both goods after the capital supply increase,

1. Cloth production increases a lot and food production increases only slightly.

2. Food production increases a lot and cloth production increases only slightly.

3. Cloth production increases and food production decreases.

4. Food production increases and cloth production decreases.