Suppose Country X is relatively labor-abundant and relatively land-scarce. Country Y is relatively labor-scarce and relatively land-abundant. The production of corn is relatively land-intensive while the production of shoes is relatively labor-intensive. Explain the short- and long-run effects of opening to free trade between these countries on the incomes of: workers employed in the production of corn in each country; workers employed in the production of shoes in each country; land used in the production of corn in each country; and land used in the production of shoes in each country.

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE: As the countries engage in free trade, the product prices will be equal in the two countries. Once product prices have responded to free trade, the production in the two countries will respond to the new prices. Country X will expand its production of shoes reduce and its production of corn. Country Y will expand its production of corn and reduce its production of shoes. In the short run, the resources in Country X involved in the production of shoes will gain, and the resources involved in the production of corn will lose. In Country Y the reverse trend is observed. The resources involved in the production of shoes lose, and the resources involved in the production of corn gain.

In the long run, resources can shift employment between industries within each country, so the difference between the returns to the same resource in different industries in a country disappears. Country X exports shoes, and the production of shoes is labor intensive, so wages in Country X will rise and rents will fall. In Country Y, again, the reverse trend is observed: wages will fall and rents will go up.