Question

Consider a 2x3 specific-factors model, with all associated assumptions, where HOME is a small country and has two sectors, (1) light manufactured goods and (2) industrial goods, and three factors, (i) capital (which is mobile between sectors), (ii) unskilled labor (which is specific to light manufactures) and (iii) skilled labor (which is specific to industrial goods).

(e) Suppose, after opening to trade, HOME experiences a significant inflow of foreign direct investment (FDI). What do you expect to happen to the production of light manufactures and the production of industrial goods? Explain.

(f) Suppose, after opening to trade, Home experiences a significant inflow of foreign direct investment (FDI). What do you expect to happen to the real return to capital? Explain.

(g) Suppose, after opening to trade, Home experiences a significant inflow of foreign direct investment (FDI). What do you expect to happen to the real return to skilled labor? Explain.

(h) Suppose you are deciding between relying on capital as your primary source of income OR relying on your labor as your primary source of income. Moreover, imagine you had to make this decision before learning Home’s comparative advantage. To what extent would you face a risk-reward tradeoff in the context of this model? Explain.

Answer 1

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