Assume that Country A is relatively abundant in labor and Country B is relatively abundant in land. Note that wages are the returns to labor and rents are the returns to land. According to the factor price equalization theorem once Country A begins specializing according to comparative advantage and trading with Country B

 Options:

a. wages and rents should fall in Country A b. wages and rents should rise in Country A c. wages should rise and rents should fall in Country A d. wages should fall and rents should rise in Country A

The Correct Answer Is:

c. wages should rise and rents should fall in Country A

Correct Answer Explanation: c. wages should rise and rents should fall in Country A

The Factor Price Equalization Theorem (FPE) is an economic principle that suggests that when countries specialize in producing goods based on their comparative advantage and engage in trade, the prices of factors of production like wages and rents should equalize across those countries.

Country A being relatively abundant in labor means it has a comparative advantage in producing labor-intensive goods, while Country B, abundant in land, has a comparative advantage in land-intensive goods.

So, when Country A starts specializing and trading according to its comparative advantage, several things are expected to happen:

• Wages in Country A should rise: As Country A specializes in goods requiring more labor, the demand for labor increases. With an increase in demand and the relatively abundant supply of labor, wages should rise due to this increased value of labor.
• Rents in Country A should fall: Conversely, as Country A moves away from producing land-intensive goods, the demand for land decreases. This decreased demand for land should result in a reduction in rents since the value of land decreases due to lower demand.

Now, let’s address why the other options are not correct:

a. Wages and rents should fall in Country A:

This option contradicts the predictions of the FPE theorem. According to the theorem, when a country specializes in goods according to its comparative advantage and engages in trade, the prices of factors of production, like wages and rents, should equalize or move towards equalization between countries.

In the context of Country A specializing in labor-intensive goods, there would be an increased demand for labor due to this specialization. This increased demand for labor would likely drive wages up rather than causing them to fall.

Meanwhile, as Country A moves away from producing land-intensive goods, the demand for land decreases, leading to a reduction in rents rather than an increase. Therefore, both wages and rents in Country A are expected to move in the opposite direction to what this option suggests.

b. Wages and rents should rise in Country A:

This option also deviates from the predictions of the FPE theorem. When a country specializes in goods according to its comparative advantage, the prices of factors of production should adjust accordingly.

In the case of Country A specializing in labor-intensive goods, the increased demand for labor should push wages up. However, the decrease in demand for land-intensive production should result in a decrease in rents, moving in the opposite direction from what this option suggests.

Therefore, while wages might rise due to increased demand for labor, rents are anticipated to fall due to reduced demand for land.

d. Wages should fall and rents should rise in Country A:

Once again, this option conflicts with the predictions of the FPE theorem. As Country A specializes in labor-intensive goods, the increased demand for labor should push wages upward.

However, the reduced demand for land-intensive goods would lead to decreased rents as the value of land decreases due to lower demand. Therefore, wages are expected to rise while rents should fall in Country A rather than moving in the opposite direction as suggested in this option.

In summary, the Factor Price Equalization Theorem anticipates adjustments in factor prices such as wages and rents when countries specialize in goods based on their comparative advantage and engage in trade.

The correct outcome, as explained earlier, would be rising wages and falling rents in Country A due to increased demand for labor and decreased demand for land-intensive production.

Related Posts

• The effective rate of protection
• A foreign-trade zone (FTZ) is