Consider two countries, Home and Foreign. Both countries produce only one good, output, with two factors of production, capital and labour. The supply of capital and the technology to produce the good are the same in both countries and are fixed. The marginal product of labour in each country depends on employment and it has the form:
MPL = 21 – L
Where L is the quantity of labour employed in production. Initially Home has 11 units of labour employed in the industry, whereas Foreign has only 3.
a) Assume that labour is not allowed to move across countries. Use the marginal product of labour curve to determine the real wage and the distribution of income between workers and capitalists in each country. Show it in a graph.
b) Which country has higher real wages? Explain the intuition behind your answer.
c) Assume now that countries sign an agreement that allows free migration of workers across countries. Find the effect of this free movement of labour on each country’s employment and real wages. Show it in a graph. Explain.
d) Use graphs to compare the income of workers and capitalists before and after trade in each of the two countries. Explain.
e) Who wins and who loses after opening to trade? Explain the intuition behind your answer.