Real wages and non-traded goods

This paper examines the connection between a terms-of-trade improvement and the real wage rate for a country that is immersed in a trading world with many traded commodities as well as a non-tradeable. There is an array of commodities that are imported but not produced at home, and the price of one of these commodities is lowered, which would, by itself, raise real wage rates if local wage rates are tied to world prices with sufficient diversity in local production to tie factor prices to world commodity prices. If the improvement is sufficiently great, the home country may cease production of one of its tradeables, and the price of non-tradeables changes to clear its market. Details of how this affects the real wage rate depend upon two attributes: Is the non-tradeable labor-intensive relative to the remaining tradeable, and is the income effect of increasing the demand for non-tradeables overpowered by the substitution effect tending to reduce demand? Furthermore, with large changes new traded commodities enter the production mix, so that factor prices once again are tied to world prices. And a wealthier country with the same technology may find its real wage improving at the same time as the opposite change takes place in the home country. (C) 2011 Elsevier Inc. All rights reserved.