Question

If demand for a country’s export good rises, other things being equal, will both the commodity terms of trade and the income terms of trade improve? Explain

Answer 1

Answer:

If the demand increases for the export good is by the foreign country, the terms of trade will improve by an equal amount in either instance. If it is the large country, the normal upward shift in the foreign offer curve occurs. If it is the small country, the straight line offer curve by the foreign country pivots to higher country terms of trade for home country. If demand increase for export good is by home country the home country's offer curve pivots inward. In this case if the country is large the terms of trade will improve but if the home country is small there is no impact on terms of trade.

The commodity terms of trade ratio for 2005 is 92.3 and the income terms of trade ratio for 2005 is 106.3. The commodity terms of trade deteriorated from 1995 to 2005 while the income terms of trade improved. This occurs when relative decline in export prices stimulated an elastic response of quantities demanded of country's exports.