Suppose that the home country in the two-sector (manufacturing and agriculture) specific-factors model has a comparative advantage in agricultural output. What will happen to the return (rental) on capital when trade occurs?
A) It will fall.
B) It will rise.
C) It will not change.
D) It will first fall, then rise.

Question

Quizplus · Accepted Answer

In the two-sector specific-factors model, when the home country has a comparative advantage in agricultural output, after trade, the home country will export agricultural goods and import manufactured goods. This will increase the demand for agricultural production, and therefore increase the return on land and labor used in agriculture. However, the demand for capital in agriculture will decrease as a result of the shift towards more labor-intensive production, which will lead to a decrease in the return on capital in agriculture. Since the manufacturing sector is capital-intensive, the demand for capital in manufacturing will increase, leading to an increase in the return on capital in the manufacturing sector. Overall, the net effect will be a fall in the return on capital in the economy as a whole.

Suppose That the Home Country in the Two-Sector (Manufacturing and Agriculture)