Suppose there are initially two closed economies, Country A and Country B. Assume A has a relative abundance of capital, while B has a relative abundance of labor.

 

a) Prior to opening for trade, how do the initial real wages compare across the two countries? How do the initial real interest rates compare? How do you know?

 

b) After opening for trade, if we assume perfect capital and labor mobility, in which direction will capital flow? In which direction will labor migrate?

 

c) What is the result of open borders on the real interest rate and real wage rate in Country A?  

Answer rating: 100% (QA)

a Prior to opening for trade in Country A where capital is relatively abundant the initial real wages are likely to be higher compared to Country B which has a relative abundance of labor This is based on the theory of factor abundance and factor prices In a capitalabundant country the return to capital real interest rates tends to be higher leading to higher wages for workers So initial conditions might involve higher real wages in Country A and lower real wages in Country B Similarly the real interest rates in Country A would be relatively high due to capital abundance while in Country B they would be relatively low due to labor abundance b After opening for trade with perfect capital and labor mobility capital is expected to flow from the capitalabundant Country A to the laborabundant Country B This is because capital seeks higher returns and in a laborabundant country the return to capital tends to be higher Meanwhile labor will migrate from laborabundant Country B to capitalabundant Country A in search of higher wages c The result of open borders on the real interest rate and real wage ... View the full answer