Consider the country of Lilliput in the context of the specific factors model. Capital is specific to the manufactures sector, and land is specific to the food sector. Labor is perfectly mobile between sectors. Lilliput is small on world markets, freely trades at world prices and exports manufactures. Briefly explain your answers.

a. Draw a labor market diagram for this economy which shows both how labor is allocated across the two sectors as well as the determination of the equilibrium wage. Explain.
b. On your diagram from part a, show what happens when there is a decrease in the price of manufactures. Explain.

(i) Explain the changes in the diagram and indicate the new allocation of labor across sectors. (ii) What happens to production of food and manufactures as a result of this change?
(iii) What are the effects of this change on the well being of capitalists, landlords, and workers? Fully explain the economic mechanisms at work in describing the changes in the returns to these three factors of production. This should include two additional diagrams showing the effects on landowners and capitalists. 

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a As per the specific factor model in Lilliput economy at W1 wage the labour market is in equilibriu... View the full answer