Question

Assume two countries Argentina and Brazil that produce two goods, corn and wine. Assume that land is specific to corn, capital is specific to wine, and labor is free to move between the two industries. Assume that Brazil has a comparative advantage in corn, and Argentina has a comparative in wine. Brazil and Argentina sign a free trade agreement, and we want to study the consequences of this trade agreement.

a) Is it possible that real wages move in opposite directions in these two countries with the trade agreement? Explain.

b) What is the impact of opening trade on the real return to capital and land in Brazil and in Argentina? Explain.

c) In each country, has the specific factor in the export industry gained or lost, and has the specific factor in the import industry gained or lost? Explain

d) Now assume that corn is produced with labor and capital (instead of land). Moreover, Brazil and Argentina, as part of the agreement, implement reforms so that capital and labor become perfectly mobile across industries. Assume that wine is capital intensive relative to corn. Brazil still has comparative advantage in corn and Argentina in wine. Which group, capital owners or workers, are better off with the trade agreement in Brazil and in Argentina compared with autarky? Explain.

Answer 1

There are 2 countries: Argentina and Brazil. Brazil has advantage in corn and Argentina in wine. Since corn is land intensive and wine is capital intensive, we can infer that Brazil is more land abundant and Argentina is more capital abundant. Labor is allowed to move between countries.

It also mean that after trade, price of corn will increase and price of wine will fall in Brazil. Thus, price of wine will increase and price of corn will fall in Argentina.

a) After free trade , since corn will become expensive than before, labor shifts toward producing corn. Thus, returns from land increases. Simultaneously, because of fall in wine prices, returns from capital falls. Exactly opposite will happen in Argentina. Since labor is allowed to move freely, in the long run, real wages in both the sectors will even out. Nonetheless, real wages can move in opposite directions if labor isn't allowed to move freely.

b)BRAZIL: labor moves toward producing corn. Price of corn also increases, while price of wine falls. In this way, by and large price level has fallen. Thus, real returns from land increases.

labor begins shifting ceaselessly from capital. Also , there is fall in price of wine, however corn price has risen. S, real return from capital falls.

ARGENTINA: labor moves toward producing wine. Price of wine likewise increases, while price of corn falls. In this way, by and large price level has fallen. In this way, real returns from capital increases.

labor begins shifting ceaselessly from land. Likewise, there is fall in price of corn, however wine price has risen. S, real return from land falls.

c) In each country, the specific factor in export industry has gained in real terms. In any case, specific factor in import industry has fallen. Component has been explained above.

d) Corn is also produced using capital and labor, but it is more labor intensive. Wine is more capital intensive. Brazil has advantage in corn, which means it is more labor abundant than Argentina. Brazil exports corn and Argentina exports wine.

After free trade, price of corn increases/decreases in Argentina/Brazil and price of wine increases/decreases in Argentina/Brazil.

BRAZIL: Returns from labor increases because price of corn has increased, which increases the value of marginal product of labor. Wages rise

capital intensive wine becomes cheaper. value of marginal product from capital falls. So, capital owners loses.

ARGENTINA: Returns from capital increases because price of wine has increased, which increases the value of marginal product of capital.

labor intensive corn becomes cheaper. value of marginal product from labor falls. So, wage-earners loses.

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