The goal of the question is to examine the allocation of labor and the distribution of income within a country following a change in relative price of a good. (Specific Factors Model)
Given that:
Demand for labor, DDL = f (P, w)
Wage, w = P * MPL
where P = Price of a good
MPL = Marginal Productivity of Labor
Suppose Home economy produces 2 goods, Food and Cloth, using labor, land, and capital. Land is specific to the Food sector and capital is specific to the Cloth sector. Labor is the mobile factor implying that labor and land are used to produce Food; land and capital are used to produce Cloth.
If the price of Food, PF, increases by 8% but the price of Cloth, PC, remains unchanged, what is the effect on the incomes of the following groups in the Home economy:
(1) Workers [Be sure to include the concepts of nominal and real wages in your explanation].
(2) Capitalists [Base your answer on capitalists' profits, the real wages they pay their workers, and purchasing power for food].
(3) Landowners [Base your answer on Landowners' profits, the real wages they pay their workers, and purchasing power for food].
(4) Use a table to summarize your answers from parts (1), (2), and (3). Who are better off with the price change? Who are worse off?
(5) Which of the assumption or assumptions of the Specific Factors Model may justify income redistribution from the groups that are better off to groups that are worse off? Explain.