Economics

Consider a country (Home) where production can be represented with a Heckscher-Ohlin model with two industries [Forestry (F) and Agriculture (A)], and two inputs [labour (L) and Land (T)]. Both Labour and Land are fully mobile across sectors (all land can be used to support either forests or farming; and similarly all labour can work in either sector. Let w be the wage and let r be the return to land. Assume that agriculture is labour intensive relative to forestry. The economy is initially in free trade. Assume the economy is small so that goods prices are fixed. That is, pF and pA are determined in world markets and nothing that this country does will affect the world prices pe and pa. Suppose that there is an increase in productivity in the Forestry sector. That is, for any amount of land and labour used in Forestry, more output can be produced (the marginal products of both land and labour are higher in F). There is no change in productivity in A.

1. What happens to outputs ofF and A? Use a diagram and explain.
2. Use a diagram with w/r on the vertical axis and L/T on the horizontal axis to show how w/r is affected by the increase in productivity in F.
3. What happens to the real return to labour? Explain.
4. What happens to the real return to land? Explain.