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Substituting the information above gives
We use the very same approach for the rental on land, recognizing that ∆
= 0 since the
price of agriculture stays the same. The change in land rental is
And in a similar approach for the rental on capital, we include the percentage changes for
the price of agriculture (∆PA/PA), wage (∆W/W), and rental on land (∆RT/RT) and rewrite
the equation for the percentage change in rental on land as
Using the data for agriculture, we get that the fall in the land rent (5%) exactly equals the
percentage increase in the wage (5%) as follows:
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General Equation for the Change in Factor Prices We can summarize our finding with
regard to the impact of a short-run change in factor prices with the following:
In other words, due to an increase in the relative price of manufacturing, capital owners
are better off because the real rental on capital rises by more than the hike in the
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Furthermore, landowners would also be better off if the price of the agricultural good
What It All Means These general equations show that the specific factor in the sector
whose price has increased gains, while the specific factor in the other sector loses.
APPLICATION
Prices in Agriculture
The prices of agriculture products such as cotton, palm oil, rice, sugar, rubber, wheat, and
wool have declined as countries become productive in growing crops, which results in an
Coffee Prices The price of coffee fluctuates greatly because the beans are only grown in
developing countries. As shown in Figure 3-8, the real, wholesale prices of coffee often
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fluctuate. The world coffee prices reached as high as $3.00 per pound in 1986 to a low of
50¢ per pound in 2001. The swing in the world coffee prices is due to excess exports
Fair-Trade Coffee To assist coffee growers in developing countries, TransFair USA, an
import group, engages in “fair-trade coffee” by avoiding the middlemen and ensuring a
minimum price for the farmers. The fixed fair-trade price is a form of insurance against
H E A D L I N E S
Rise in Coffee Prices—Great for Farmers, Tough on Co-ops
Fair-trade cooperatives had difficulties obtaining deliveries from member farmers when
the price of coffee beans rose above their agreed fair-trade price of $1.26 per pound. The
4 Conclusion
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The specific-factors model is a short-run model in which labor is perfectly mobile
between industries, although other inputs such as land and capital are specific to the
industry in which the factor is used. Under these assumptions, the factor specific to the
import-competing industry loses in terms of its ability to purchase the goods produced
TEACHING TIPS
Tip 1: Coffee Prices and Factor Returns in the Real World
In this chapter, we discuss the effect of goods’ prices on returns to both fixed and mobile
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Tip 2: U.S. Employment Since the Global Recession
(TAA). When this book was written, the global economy was just beginning to recover
from a major global recession that greatly affected international trade. Ask your students
Tip 3: Discussion About the Global Economy
Beginning in Chapter 1, there has been a focus on the changing face of trade. This
emphasis was continued with our discussion of the TAA being extended to the service
IN-CLASS PROBLEMS
1. Use the following information to answer the questions below:
Computers: Sales revenue = PC · QC = 150
Payments to labor = W · LC = 75
Payments to capital = RK · K = 75
Barley: Sales revenue = PB · QB = 150
Payments to labor = W · LB = 70
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Payments to land = RT · T = 80
Holding the price of computers constant, suppose the percentage increase in the price
of barley is 10% and the percentage increase in wage is 5%.
a. Determine the impact of the increase in the price of barley on the rentals on land.
Answer:
b. Determine the impact of the increase in the price of barley on the rentals on
capital.
Answer:
c. Determine the impact of the increase in the price on the welfare of labor.
Answer: The impact of the increase in the price of barley on the welfare of labor
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2. Summarize your finding in Problem 1 using notational format.
∆
⁄< 0 < ∆
⁄<∆
⁄<∆
⁄, ↑
3. If, instead of the situation given in Problem 1, the price of computers was to fall,
would landowners or capital owners be better off? Explain. How would the decrease
in the price of computers affect labor? Explain.
Answer: Similar to the situation given in Problem 1, capital owners would be worse
4. What is fair trade?
Answer: Fair trade is the process by which nongovernmental organizations such as
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5. Ashland is considering whether to engage in the international trade of rice and
furniture. Suppose that the world price of rice is lower than Ashland’s no-trade price,
but its no-trade furniture price is lower than the world price. Assume that land is
specific to the production of rice and that labor is free to move across sectors. Do you
think the landowners will support the move to free trade? Explain.
6. When labor shifts from agriculture to manufacturing, why does the marginal product
of capital increase, while the marginal product of land falls?
7. Between 2005 and 2007, displaced workers in the service industries were better off
relative to those in the manufacturing industries. Comment.
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8. Assuming that labor is mobile, is it true that wages always must be equal across the
sectors in the specific-factors model?
9. Home, a small, open economy, uses a mobile factor (labor) and two specific factors
(drylands and wetlands) to produce two goods, cactus and rice. Dryland is only
productive in growing cactus and wetlands can only grow rice. Suppose the world-
relative price of cactus is higher than Home. Determine the effect of this price
increase on the real wage and real returns on the different types of land.
Answer: Because the world-relative price of cactus is higher than Home, the small
