What would be the effect of changes in factor supplies, for example labor, on the open economy equilibrium?
Let us assume that the labor supply increases. Below I list some of the consequences that occur in the model:
- Wage adjustment: An increase in labor supply typically leads to a decrease in wages due to a higher availability of workers for the same number of jobs. This reduction in wages affects production costs, firm behavior, and the overall labor market.
- Lower production costs: As wages decline with increased labor supply, firms' production costs decrease. Lower production costs lead to lower prices, making firms more competitive, both domestically and internationally.
- Firm selection and entry: With lower production costs, firms with lower productivity levels now find it profitable to enter the export market. This increases the number of firms exporting and intensifies competition in both domestic and international markets.
- Consumer prices: Lower production costs and increased competition result in lower prices for consumers, raising their purchasing power. Additionally, the entry of new firms into the market expands product variety, further benefiting consumers.