• World equilibrium relative price of x: ${\left(\frac{p_x}{p_y}\right)}^2$ balances Home's exports and Foreign's imports of x

• As countries trade, changes relative price of x in each country until both reach equilibrium world relative price (B,B'), where both countries have same relative price:

$${\left(\frac{p_x}{p_y}\right)}^H<{\left(\frac{p_x}{p_y}\right)}^2<{\left(\frac{p_x}{p_y}\right)}^F$$

Home

Home

Home

Home

Home

Home

• Is economic growth in other countries good or bad for our country?
  • Good: larger markets for our exports, lower prices for our imports
  • Bad: increased competition for our exporters and for our domestic producers competing with imports

• Is economic growth in our country more or less valuable when we are part of a globalized world economy?
  • Good: we can sell more to the world market
  • Bad: the benefits of our growth don't stay at home, are dispersed to foreigners importing at cheaper prices

• Terms of trade are another name for the relative price of $x$ or $y$ in the international trade equilibrium

• We express the terms of trade (TOT) for a country as the relative price of that country's exports:

  • How many imports does a country gain per export

$$TOT=\frac{p_{exports}}{p_{imports}}$$

$$TOT=\frac{p_{exports}}{p_{imports}}$$

• In our examples:

  • For Home (exporter of x): $TOT=\frac{p_x}{p_y}$
  • For Foreign (exporter of y): $TOT=\frac{p_y}{p_x}$

• The terms of trade can change over time as countries' supply (of exports) and demand (for imports) changes

Home

Home

Home

• Suppose equilibrium relative price of x decreases (relative price of y increases): slope gets flatter

• Foreign (exporter of y, importer of x) reaches a higher indifference curve (at D') than before (at C')

• Foreign's TOT: $\frac{p_y}{p_x}$ strengthened (more imports per export)

Home

• Recall, terms of trade can only fall within the range between countries' relative autarky prices!

$$(\frac{p_x}{p_y}{)}^H<(\frac{p_x}{p_y}{)}^{\star }<(\frac{p_x}{p_y}{)}^F$$

• But there is still room for TOT to increase or decrease

• Economic growth: an outward expansion of a country's PPF
  • increase in productivity
  • generating greater output with (fewer) inputs

• Economic growth: an outward expansion of a country's PPF
  • increase in productivity
  • generating greater output with (fewer) inputs

• Economic growth: an outward expansion of a country's PPF

  • increase in productivity
  • generating greater output with (fewer) inputs

• Here we demonstrate balanced growth, where relative prices (slopes) remain unchanged

• Economic growth is often biased towards particular industries

• Economic growth is often biased towards particular industries

• Growth biased towards x: increases relative supply of x

  • (If we graphed market for y, would decrease relative supply of y)

• Will push down relative price of x (push up relative price of y)

• Growth biased towards y: decreases relative supply of x

  • (If we graphed market for y, would increase relative supply of y)

• Will push up relative price of x (push down relative price of y)

• What is important is not which country grew, but which industry

• Recall each country's terms of trade are:

$$TOT=\frac{p_{exports}}{p_{imports}}$$

• Events that raise (lower) price of our exports raise (lower) our TOT

• Events that raise (lower) price of our imports lower (raise) our TOT

“How many imports can we buy with a unit of our exports?”

• Recall each country's terms of trade are:

$$TOT=\frac{p_{exports}}{p_{imports}}$$

• Events that raise (lower) price of our exports raise (lower) our TOT

• Events that raise (lower) price of our imports lower (raise) our TOT

“How many imports can we buy with a unit of our exports?”

• Often compare export industries & import industries growth

• Export-biased growth tends to worsen a growing country's TOT, to the benefit of the rest of the world

  • Raises other importing countries' TOT

• Import-biased growth tends to increase a growing country's TOT, to the expense of the rest of the world

  • Lowers other exporting countries' TOT

• Trade is a positive sum game!

• Regardless of what TOT are, both countries are still consuming beyond their PPFs!

• We are arguing about how far each country gets beyond its PPF

• The distribution of the gains from exchange are zero sum

• Both countries are “winners”, this is about “who wins more?”

• Exports are the price a country pays for imports!

• Exports are a cost! (our consumers lose them)

• Imports are a benefit! (our consumers gain them)

• We have still been considering countries as a whole

  • A “national” indifference curve

• Trade benefits entire nation in aggregate (for both countries)

• TOT trade changes affect how much a nation gains from exchange