Question

Question 3 3 pts Suppose the U.S. is capital-abundant and Mexico is labor-abundant. After opening up to trade, the wage-to-rental-rate in the US economy will , and the welfare of the workers in the US will o not change, increase increase, decrease O increase, increase o decrease, not change O decrease, decrease

Answer 1

The last option of decrease, decrease is correct.

This result follows from the H-O model, Stolper-Samuelson (S-S) theorem and Ronald Jones magnification effect.

As per H-O model, the capital intensive nation will export capital intensive goods. Now before opening up of trade the capital intensive product is cheaper in US than in Mexico, which is why on opening up of tade, traders sell capital intensive good in Mexico where price for those goods are high. Trade continues until prices in both nation equalize. For that the price of capital intensive good will increase in the US. This is where S-S theorem comes in which states that if the price of the capital-intensive good rises, then the price of capital—the factor used intensively in that industry—will rise, while the wage rate paid to labor will fall. Hence the rent in the USA will rise and wages will fall. Thus wage-to-rental rate decreases in the US.

A corollary of the magnification effect is that when trade opens up. the real return from the nations relatively abundunt factor increases while the real return from country's scarce resources decline. In our context wages fall and the real returns for laborers will fall. Hence there is a decrease in their welfare.

The above explanation should suffice for why the other options are incorrect.