Question

B2. (20 marks) Consider a small-open economy, "Home", that produces two goods: forest product (F) and manufacturing products (M). Assume a Specific Factors model. Suppose forest products are produced with land (T) and labour (L), and manufactures are produced with capital (K) and labour. Labour is freely mobile across industries. Suppose that the price of F decreases while the price of M stays the same. What happens to the real wages, and the real returns to capital and land? What happens to the labour employment in the forest and manufacturing sector? Use diagrams to support your answer.

Answer 1

Solution:

In this condition the real wages reduces for the labor working in both the sectors considering no labor is removed from the job. Hence there will be a situation that labor's are shifted from forest product department (F) to manufacturing products(M) hence this will also have an affect on the labor wages of manufacturing unit.

Also % profit= (yield/cost of investment)*100 hence from this it is clear that as the price reduces the yield also reduces hence the returns to capital and land also decreases.

I have taken cases so that we can plot a hologram diagram  for it.

Table for depicting the effect on forest products after decreasing the price of forest products

	value before reduction	value after reduction
price	100$	90$
wage value	40$	35$
no of labor	50	40

908 1008 e of I forest produck Pn $.

This graph clearly explains that with reduction in prices of commodities of forest the wage value also decreases.

Table for depicting the effect on manufacturing products after decreasing the price of forest products

	value before reduction of forest products value	value after reduction of forest products value
price	120$	120$
wage value	50$	40$
no of labor	60	70

Now the condition when the labors are removed because the sales go down for the forest products hence it effects the employment

	value before reduction of forest products value	value after reduction of forest products value
sales (no of commodities sold)	10,000	8,000
no of labor	50	40

70,0007 8,000 6,000+ 4,000 2,000 50 (no of abor)

This graph explains that with reduction in sale the number of labors gets reduced.