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∆
=
(∆
)·−∆
··
Substituting the information above gives
We see that the percentage increase in the rental on capital, 17.5%, is far greater than the
percentage increase in the relative price of manufacturing, 10%.
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
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
percentage change in the price of manufactures. Wages also increase, but by less than the
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Furthermore, landowners would also be better off if the price of the agricultural good
rises. In particular, we can summarize the effect as
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.
Moreover, the factor “caught in the middle,” namely labor, gains on the one hand in
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
increase in the global supply. The specific-factors model predicts that landowners, like
the farmers, lose in real terms due to the decrease in the relative price of agriculture.
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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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
co-op’s leader convinced the farmers to deliver the coffee by drawing on their sense of
loyalty.
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
factors of production. Have your students look up the most recently available world
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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
to visit the Bureau of Labor Statistics for the Labor Force Statistics from the Current
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
industry. Have your students discuss why this change is important, and how greater
global competition in services will affect them.
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
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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.
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
off because the rental on capital would fall by more than the decrease in the computer
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?
Answer: When labor shifts from agriculture to manufacturing, the marginal product
7. Between 2005 and 2007, displaced workers in the service industries were better off
relative to those in the manufacturing industries. Comment.
Answer: According to Table 3-1, although the number of workers displaced between
2005 and 2007 was significantly higher (more than double) in the service industries
relative to the manufacturing industries, 68% of the workers in the service industry
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found employment by January 2008, with 56% of those newly employed workers
earning the same or more in their new jobs. By contrast, 64% of the displaced
workers in manufacturing were re-employed by January 2006 and only 51% received
the same or higher pay in their new positions.
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.
