4.2. Prices & Income Distribution Flashcards
Equal-proportional change in price
When the price of cloth and food changes together, no real change occurs.
Both prices increase by 10%, therefore labour demand curves shift up by 10%.
This causes a 10% increase in the wage.
Overall no real change occurs as the wage rate rose in the same proportion as the prices.
Change in relative price
When the price of one good rises more than another, there is an effect.
Image cloth rises by 7%.
The labour demand curve rises by 7%.
The wage rate rises, but by less than 7%. This is because:
- As Pc rises, the wage rises, labour transitions over from the food industry to benefit from the higher wages.
- The total output of clothes rises and the total output of food falls.
But, the MPLc falls and MPLf rises. This falling MPLc stops the wage rate rising the same 7%.
Change in relative prices changes the production point
The economy produces where -MPLf/MPLc = -Pc/Pf.
If Pc/Pf changes, then it will equal -MPLf/MPLc at a different position.
Food output falls and cloth output rises, as a result of the increase in the relative price of cloth.
Relative supply and demand curves can be drawn in.
Distribution of income
If the wage rate rises by less than the rise in the price of cloth:
Workers:
- Real wage in terms of cloth has fallen (w/Pc).
- Real wage in terms of food has risen (w/Pf).
- Whether the workers are better or worse off from this depends on their consumption preferences.
Capital owners:
- As the real wage in terms of cloth has fallen, they are making more profit on cloth.
- The income of the capital owners will rise proportionately more than the rise in Pc.
Land owners:
- As the real wage in terms of food has risen, they are making less profit on food, squeezing their income.
- Furthermore, the rise in Pc reduces the purchasing power of any given income.
The factor specific to the sector whose relative price falls is definitely wrose off.
The factor specific to the sector whose relative price rises is definitely better off.
