Suppose that due to a drought, the price of agricultural goods rises by 10%. If land is specific to agriculture, capital is specific to manufacturing, and labor is mobile between sectors, which of the following is true?
A) The percentage change in labor income is less than zero.
B) The percentage change in labor income is greater than 10%.
C) The percentage change in returns to capital is greater than 10%.
D) The percentage change in labor income is less than 10%.

Question

Quizplus · Accepted Answer

Since labor is mobile between sectors, the increase in demand for labor in agriculture will lead to an increase in wages in that sector, but at the same time, the decrease in demand for labor in manufacturing may lead to a decrease in wages in that sector. However, we cannot determine for sure the exact percentage change in labor income without more information on the elasticity of labor supply and demand in the two sectors. Therefore, the correct answer is D, which simply states that the percentage change in labor income is less than 10%, as we cannot assume it is greater than 10%. The other two choices are also incorrect, as the question only mentions the effect on the price of agricultural goods, not on returns to capital.

Suppose That Due to a Drought, the Price of Agricultural