Consider two countries: Country A, which has a relative abundance of labor, and Country B, which is relatively rich in land. Given that wages represent labor income and rents represent land income, what does the factor price equalization theorem predict will happen in Country A after it specializes based on comparative advantage and starts trading with Country B?

Show Answers

Both wages and rents in Country A will decrease.Both wages and rents in Country A will increase.Wages in Country A will increase while rents will decline.Wages in Country A will decrease while rents will increase.No significant change in wages or rents will occur in Country A.

Explanation

According to the factor price equalization theorem, when Country A, abundant in labor, specializes and trades with Country B, abundant in land, the relative returns adjust. Specifically, wages (returns to labor) in Country A rise due to increased demand for labor-intensive goods, while rents (returns to land) fall because land is less intensively used. This leads to wages increasing and rents decreasing in Country A.