Economics

Specific Factors Model of Trade

Assume Portugal can produce 2 goods Computers and timber using unskilled labour (L) that is mobile between sectors. Capital (K) is specific to producing Computers. Land (T) is specific to producing timber.

a. Use a single diagram to show how Portuguese labour (L) is allocated between computers and timber. This is the combined graph with the wage curves for each sector. Hint: The graph should represent both wages which are a function of MPL and prices. Now assume Portugal engages in free trade and in the world market the price of timber is 20% higher than in Portugal, while the price of computers does not change.

b. Redraw the diagram in point (a) and let the price of timber increase by 20%. What happens to the labour demand curves in the computers sector and in the timber sector?

c. What happens to equilibrium wages and the allocation of labour. Briefly explain your answer.

d. Who wins and who loses in Portugal after opening to trade? Briefly explain your answer.