Economic Growth and the Terms of Trade Flashcards
Remember some key things
Rybczynski Theorem
With a CONSTANT RELATIVE GOODS PRICE (TERMS OF TRADE), an increase in the endowment of one factor will lead to a greater proportionate change in the production of the good that intensively uses that factor and a reduction in the output of the other good.
Small country, labour endowment increases, what would you need to remember to include on the PPF diagram?
The TOT lines tangent to both PPFs, both with same slope representing same (Px/Py) because we keep TOT the same and it doesn’t change for small country
With these different examples of changes in endowments, productivity etc, we analyse through two steps, which are…
To keep the Terms of Trade constant and see what happens to imports and exports (i.e. the trade triangle), then see what happens to the home offer curve, and this will give us the final result with regard to the TOT
The assumptions are…
Preferences are identical and homothetic, perfect competition, X is the labour-intensive good, Y is the capital-intensive good, country is labour abundant and exports good X
What are we doing here/what are we interested in?
How a country’s economic growth affects its welfare through its effects on the TOT.
A large country may experience immiserising growth is there is a…
Large change in the TOT.
This likely to happen where…
Demand for the exportable good is inelastic (but not necessary condition), and/or the economic growth is biased towards the export industry (i.e. holding the TOT constant and the output of the importable good falls, Bhagwati, 1958)
In order for this to be the case…
Trade has to make up a large proportion of national income (i.e consumption quite far away from production on TOT line)
What can a country do to prevent immiserising growth?
We know that a large country can use a tariff or export tax to improve its TOT. Although this would result in consumption and production distortions, it would prevent the TOT from worsening. A tariff should be set that would result in the quantities of exports and imports remaining the same.
Immiserising growth occurs when a country…
Is not pursuing its optimal trade policy
When we look at immiserizing growth in the Ricardian Model, the home country only produces the exportable good, so we have to assume that…
Demand for the exportable good is inelastic, so we cannot use Bhagwati’s cause of growth being biased to export industry because this still implies that some Y is still being produced.
In the Ricardian Model, how do we work out the TOT (Px/Py) for the home country?
Equate demand and supply for the exportable good
