Since the Russian invasion of Ukraine in February 2022, many European and Amer- ican firms have stopped operating in Russia. Some of these firms had substantial investments in the country and, therefore, their exit leads to a substantial capital out- flow from Russia (i.e. a reduction in Russia's capital stock). In the following questions, you are asked to analyse the economic consequences of capital moving out of Russia in the short run and in the long run. Use the Specific-Factors model to analyse the short-run economic consequences of a reduction in capital. There are three factors of production: labour, land and capital. There are two sectors of economic activity: manufacturing and services. Manufacturing goods are produced with labour and capital and services are produced with labour and land (for this part, "land" refers to office space). Labour is mobile across sectors while capital and land are fixed in the manufacturing and service sector, respectively. The prices of manufacturing goods and services are determined in the global market and are not affected by developments in Russia. 1. Draw a graph to describe the pre-war labour market equilibrium. Depict the wage on the vertical axis and the labour force on the horizontal axis, split in manufac- turing (from left to right) and service (from right to left) employment. Draw the value of marginal product of labour for the manufacturing sector and the service sector, denote the pre-war equilibrium point by A and show the equilibrium wage W and the labour split between the two sectors L. Show on the graph the level of employment in each sector. (3 Marks) 2. Use the graph to show the short-run effect of capital outflow on the economy. De- note the new point of equilibrium by A', the new wage by W' and the new sectoral split of the labour force by L. Carefully explain the short-run effect of a post-war reduction in capital on the graph and describe how this affects the equilibrium in the labour market, particularly the reallocation across sectors. (3 Marks) 3. Suppose that Russia's ability to pursue the war in Ukraine depends on the mag- nitude of its manufacturing output. How does the exit of Western capital affect that ability? (4 Marks) 4. Are the (local) owners of capital better off or worse off after the reduction in Rus- sia's capital stock? What about land-owners? What about workers? Explain carefully how each factor of production is affected by capital outflow. (6 Marks)