Question

Suppose a country where capital is scarce and most of industry is labor- intensive with lowskilled labor moves from autarky to free trade. Which of the following do you expect to happen? Check all that apply. [LO 17.6\(]\) a. Owners of capital become wealthier. b. Wages for labor increase. c. Income disparity between workers and owners of capital increases.

Short answer

b. Wages for labor increase.

Step-by-step solution

Understand the Economic Scenario

The country described is one where capital is scarce, and industries rely primarily on low-skilled labor. Moving from autarky (being self-sufficient and not trading with other countries) to free trade means the country will begin to engage in international trade.

Analyze the Impact on Wages for Labor

With free trade, the country will likely export goods that are labor-intensive, due to its comparative advantage in low-skilled labor. As demand for these goods rises, the demand for labor also increases, likely leading to higher wages for labor.

Consider the Effect on Owners of Capital

In a labor-intensive economy, the capital used is less significant relative to labor. In a free trade environment, the industries might not be able to exploit comparative advantages associated with the utilization of capital, meaning the relative scarcity and return on capital may not significantly change, potentially leaving owners of capital with unchanged or reduced wealth relative to labor.

Examine Income Disparity

If wages increase due to high demand for low-skilled labor because of exports, and the returns to capital do not increase as much, the income disparity between workers and owners of capital may actually decrease, contrary to becoming higher.

Key concepts

Comparative Advantage

Comparative advantage is a fundamental concept in international trade. It refers to a country's ability to produce certain goods at a lower opportunity cost than other countries.

In the scenario described, the country has a comparative advantage in labor-intensive industries due to its abundance of low-skilled labor. When a country transitions from autarky to free trade, it tends to export goods that reflect its comparative advantages—here, labor-intensive products.

This happens because it is more efficient for the country to focus on producing goods that make the best use of its resources. With free trade, the country can then import other goods that require more capital from countries where capital is more abundant and thus cheaper to use.

Labor-Intensive Industries

Labor-intensive industries are those that require a large amount of labor input compared to capital. Examples include agriculture, textiles, and certain manufacturing sectors.

In a labor-intensive economy, the workforce plays a crucial role, as these industries depend heavily on human labor rather than machinery or technology.

With free trade, labor-intensive industries in the country benefit because they can now access larger markets.

• This increases demand for labor, as the country exports more labor-intensive goods.
• Local workers, therefore, experience increased employment opportunities and potentially higher wages.

Since labor is a significant component of the production costs in these industries, changes in international demand directly impact the local labor market dynamics.

Income Disparity

Income disparity refers to the difference in earnings between various groups within an economy, such as between workers and owners of capital. Although it might seem intuitive that free trade could widen this gap, the actual effect depends on the specific economic context.

In the described scenario, opening up to free trade potentially leads to higher wages for workers in labor-intensive industries because of increased demand for their output.

• This increase in labor wages can reduce income disparity between workers and the owners of capital.
• Even if returns on capital do not rise significantly, the relative improvement in wages narrows the income gap.

As a result, free trade in this case could well support more equitable income distribution by boosting earnings in sectors where low-skilled labor is prominent.