Terms of Trade(macro)

Christa WashingtonAP EconomicsMay 16, 2013

7th period

TERMS OF TRADE• Determine the rate at which one country is willing to trade one item

for another item on the world market• Trade terms may be expressed in either monetary or bartering vocab

• As monetary expression, terms of trade are stated as a world price, the subject of upcoming discussion

• When viewed from a bartering standpt, trade terms refer to the amt of certain items 2 countries are willing to exchange w/ one another

• Trade terms are influenced by eco and non eco factors and must be negotiated through a political process

• There is no unique set of optimal trade terms btwn 2 countries• A range of aceptable trade solutions exists from which the countries must select

through trade agreements• Knowing how a country benefits form specializing can help us determine how it

may benefit from trade- shifts PPC outward

SOLVING TERMS OF TRADE PROBLEMS

• If necessary, construct an output table using the data for two nations- this reps their production possibilities before trade

Item A Item B

Nation C 100 200

Nation D 40 200

CONTINUED…

• Determine the cost ratios and comparative adv of each nation

• Select one product as a reference and use its cost ration to determine its per-unit opportunity cost for each nation

Item A Item B

Nation C 2* 1/2

Nation D 5 1/5*

Nation C: 1A= 2B …Nation C not willing to trade As for less than 2Bs apieceNation D: 1A= 5B.…Nation D not willing to trade As for more than 5 Bs apiece

CONTINUED…

• Set a term of trade somewhere btwn the two boundaries

• 1A= XB where 2< X< 5• Say 1A= 3B is negotiated as a trade term

• Calculate the max amt of each item each nation can gain through trade

• Nation whose cost adv is item A should MULTIPLY its output of that item by the term of trade

• Nation whose cost adv is item B should DIVIDE its output of that item by the term of trade– Nation C: 100A x (3B per A)= 300B– Nation D: 200B / (3B per A)= 66 2/3A

CONTINUED….

• Plot the TPC for each nation and show the gains from trade, if requires

Nation C Nation D

Gains from trade

Item A

Item B

TPC

PPC

300

200

100

Gains from trade

Item A

Item B

200

40 66 2/3