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A small open economy trades food and clothing on world markets at prices P T F and P T C . This country produces both goods (clothing with capital and labor; food with land and labor) and imports food. Capital and land are fixed factors while labor can move between sectors. Policy makers are considering the imposition of a 10% tariff on food. This tariff would raise the price of food in the country by 10% and would not affect the price of clothing. All workers, capital owners and landowners share the same homothetic preferences.
(a) What will be the effect of this tariff on the returns to all 3 factors (the wage W, rental rate of capital RK, and rental rate of land RT)? If these returns increase, be sure to specify whether they will increase by more or less than the tariff (i.e. whether they will increase by more or less than 10%).
(b) Use your answer to part (a) to predict whether each factor will have any incentives to lobby the policy makers for protection (the imposition of the tariff).
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