A Model of a Two-Factor Economy An increase in the price of cloth relative to that of food, PcPF, will Raise the income of workers relative to that of landowners. w/r Raise the ratio of land to labor T/L. in both cloth and food production and thus raise the marginal product of labor in terms of both goods Raise the purchasing power of workers and lower the and lowering real rents in terms of both good al wages purchasing power of landowners, by raising real Copyright C 2003 Pearson Education, Inc Slide 4-11
Copyright © 2003 Pearson Education, Inc. Slide 4-11 ▪ An increase in the price of cloth relative to that of food, PC/PF ,will: • Raise the income of workers relative to that of landowners, w/r. • Raise the ratio of land to labor, T/L, in both cloth and food production and thus raise the marginal product of labor in terms of both goods. • Raise the purchasing power of workers and lower the purchasing power of landowners, by raising real wages and lowering real rents in terms of both goods. A Model of a Two-Factor Economy
A Model of a Two-Factor Economy Resources and output How is the allocation of resources determined? Given the relative price of cloth and the supplies of land and labor, it is possible to determine how much of each resource the economy devotes to the production of each good Copyright C 2003 Pearson Education, Inc ide 4-12
Copyright © 2003 Pearson Education, Inc. Slide 4-12 ▪ Resources and Output • How is the allocation of resources determined? – Given the relative price of cloth and the supplies of land and labor, it is possible to determine how much of each resource the economy devotes to the production of each good. A Model of a Two-Factor Economy
A Model of a Two-Factor Economy Figure 4-5: The Allocation of resources Increasing Labor used in food production LF F g 8后 s F E+o Oc Labor used in cloth production Lc Increasing Copyright C 2003 Pearson Education, Inc ide 4-13
Copyright © 2003 Pearson Education, Inc. Slide 4-13 LF TF LC TC Labor used in food production Labor used in cloth production OF Increasing Increasing Land used in cloth production Land used in food production 1 F C OC A Model of a Two-Factor Economy Figure 4-5: The Allocation of Resources
A Model of a Two-Factor Economy How do the outputs of the two goods change when the economy's resources change? Rybczynski Theorem(effect) If a factor of production(Tor L) increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases for any given commodity prices The reverse is also true Copyright C 2003 Pearson Education, Inc Slide 4-14
Copyright © 2003 Pearson Education, Inc. Slide 4-14 ▪ How do the outputs of the two goods change when the economy’s resources change? • Rybczynski Theorem (effect): – If a factor of production (T or L) increases, then the supply of the good that uses this factor intensively increases and the supply of the other good decreases for any given commodity prices. – The reverse is also true. A Model of a Two-Factor Economy
A Model of a Two-Factor Economy Figure 4-6: An Increase in the Supply of land Increasing Labor used in food production L F o3° o≌ 0ao 2 Oc Labor used in cloth production L2c L1 Increasing Copyright C 2003 Pearson Education, Inc Slide 4-15
Copyright © 2003 Pearson Education, Inc. Slide 4-15 C L2 F L2 C T1 F T1 C F1 L1 F L1 C T2 F T2 C 1 A Model of a Two-Factor Economy Figure 4-6: An Increase in the Supply of Land Labor used in food production Labor used in cloth production Increasing Increasing Land used in cloth production Land used in food production F2 O1 F O2 F 2 OC