In the specific factors model, a 5% increase in the price of food accompanied by a 5% increase in the price of cloth will cause ________ in the welfare of labor, ________ in the welfare of the fixed factor in the production of food, and ________ in the welfare of the fixed factor in the production of cloth.

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BlackTom AI · Accepted Answer

First, I’ll restate the question and options to ensure clarity. The question asks about the specific factors model when there is a 5% increase in the price of food and a 5% increase in the price of cloth. It asks what happens to the welfare of labor, the welfare of the fixed factor in the production of food, and the welfare of the fixed factor in the production of cloth. The answer choices are:
A. a decrease; a decrease; a decrease
B. a decrease; an increase; an increase
C. no change; no change; no change
D. an increase; an increase; an increase
E. an increase; a decrease; a decrease

Option A: a decrease for all three groups. This would imply that an equal 5% rise in the prices of both goods reduces welfare across all parties. In the specific factors framework, if both prices rise by the same proportion, the price level overall is higher, but real incomes (welfare) depend on relative prices and the real purchasing power of wages and factor payments. Since all prices in the economy rise by the same percentage, real incomes measured in terms of the basket of goods do not necessarily deteriorate for all groups. In particular, the absence of a change in the terms of trade for labor and fixed factors under a proportional price change makes a universal decline unlikely. Therefore this option is not consistent with standard results.

Option B: a decrease for labor, but increases for the fixed factors in both sectors. This would require a redistribution effect where labor loses despite both fixed factors gaining. However, with proportional price increases in both goods, the revenue shares and the real incomes of fixed factors are typically offset by the proportional rise in prices, leaving real incomes unchanged for each group. Thus this option misstates the direction of welfare changes and is not consistent with the model under proportional price changes.

Option C: no change for labor, no change for the fixed factor in food, and no change for the fixed factor in cloth. This aligns with the intuition that a uniform, proportional increase in all prices (a 5% rise in both food and cloth prices) leads to a proportional rise in nominal payments to factors, while the relative prices faced by each factor remain the same. Since the specific factors model grants each fixed factor income tied to its sector, and labor can adjust across sectors, a uniform price increase does not alter real wages or real welfare terms for these agents when evaluated in normal purchasing power terms. In short, the proportional price increase preserves real incomes, yielding no change in welfare.

Option D: an increase for all three groups. This would require a rise in welfare across the board due to the price change. While nominal incomes rise with higher prices, real welfare depends on the purchasing power of these incomes relative to the cost of living. A uniform price increase keeps relative prices constant, so the real value of incomes to each group is not necessarily higher. Therefore this option overstates the effect and is not consistent with the standard result.

Option E: an increase for labor, but decreases for both fixed factors. This would imply labor gains from higher prices while fixed factors lose. Again, with proportional price increases and no shift in relative prices, there is no principled mechanism in the specific factors model for fixed factors to experience a decline while labor benefits, unless there are additional constraints or frictions. Hence this option is inconsistent with the standard proportional-change scenario.

SESS0063_24-25 Test your knowledge

In the specific factors model, a 5% increase in the price of food accompanied by a 5% increase in the price of cloth will cause in the welfare of labor, in the welfare of the fixed factor in the production of food, and in the welfare of the fixed factor in the production of cloth.

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