Chapter 31-Terms of Trade

1) Terms of Trade determine the rate at which one country is willing to trade one item for another item on the world market
     a) Trade terms may be expressed in either monetary or bartering vocabulary
            i) As a monetary expression, terms of trade are stated as a world price, the subject of upcoming discussions
           ii) When viewed from a bartering standpoint, trade terms refer to the amount of certain items two countries are willing to exchange with one another
      b) Trade terms are influenced by economic and non-economic factors and must be negotiated through a political process
      c) There is no unique set of optimal trade terms between two countries
           i) A range of acceptable trade solutions exists from which the countries must select through trade agreements
          ii) Knowing how a country benefits from specializing can help us determine how it may benefit from trade-shifts its PPC outward

2) Solving terms of trade problems
      a) If necessary, construct an output table using the data for two nations-this represents their production possibilities before trade

        b) Determine the cost ratios and comparative advantage of each nation

         c) Select on product as a reference and use its cost ratio to determine its per-unit opportunity cost for each nation

                 Nation C: 1A=2B         Nation C not willing to trade As for less than 2 Bs apiece

                 Nation D: 1A=5B         Nation D not willing to trade As for more than 5 Bs apiece

         d) Set a term of trade somewhere between the two boundaries

 1A=XB where 2< X< 5

Say 1A = 3B is neogoitated as a trade term

         e) Calculate the maximum amount of each item each nation can gain through trade

                    i) Nation whose cost advantage is item A should MULTIPLY its output of that item by the term of trade

                   ii) Nation whose cost advantage 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

         f) Plot the trade possibilities curve for each nation and show the gains from trade, if required

Nation C

Nation D