Question

P ($) s 24 22 20 18 16 14 12 10 8 6 4 2 02 6 4 8 10 14 12 18 22 20 24 16 (Th.)

1. There are two countries (Country X and Country Y) and two goods (T-shirts and calculators). Country X imports T-shirts and exports calculators and Country Y exports T-shirts and imports calculators. The diagram on the right depicts the international market for T-shirts. A calculator costs $90.

   1. Under free trade, what is Country X’s terms of trade? (Give a numerical answer.)

   2. If Country X imposes a $6 tariff on T- shirts, what are its new terms of trade? (Give a numerical answer. Assume the price of calculators remains unchanged.) Have Country X’s terms of trade improved or deteriorated?

Answer 1

With the diagram representing the international market for t-shirts, the price for every unit of T-shirt is $18 and the supply / quantity demanded is 20 units of T-shirts.

Country X , under free trade, adopts the international price for T-shirts and thus pays $18 for a unit of T-shirt. Also, it is said, Country X gets  $90 for every unit of calculator exported.

Terms of trade = (Export price / Import price) x 100 = (90 / 18) x 100 = 500%

Therefore terms of trade for country X is 500% ( A well over 100% indicating prices of exports are way higher than that of imports paid for)

In the second case, we see that, country X imposes a $6 tariff over it's imported t-shirts. This tariff , raises the final price of the imports for which are paid in order to buy a single unit.

New price of T-shirt after tariff = 18 + 6 = $24

New terms of trade ( keeping the price of exports constant) = (90 / 24) x 100 = 3.75 x 100 = 375%

The new terms of trade after tariff imposed over imports, is at 375%.

This indicates a significant reduction in the terms of trade from 500% t0 375% thus implying that the prices of imports have gone up. In conclusion, the decrease in the Terms of Trade means that the country's terms of trade has deteriorated.