1. Suppose just trade determines the strength of a currency. A country imports Good I and exports Good X. Because of international conditions, the price of Good I has risen 25%, while the country’s domestic production of Good I has stayed the same. The price of Good X has stayed the same as has the production level of Good X in the country. Consider the commodity terms of trade and answer the following for the country.
(a) If the quantity of its exports stays the same, what happens to the quantity of its imports?
How does this affect the level of wellbeing (satisfaction/utility) in the country? Why?
(b) If the quantity of its imports stays the same, what happens to the quantity of its exports?
How does this affect the level of wellbeing (satisfaction/utility) in the country? Why?
To answer these questions, you need to understand the concept of commodity terms of trade. The commodity terms of trade refers to the ratio at which a country can trade its exports for imports. It is calculated by dividing the price index of a country's exports by the price index of its imports.
(a) If the quantity of exports stays the same but the price of Good I (imports) has risen 25%, it means that the terms of trade have deteriorated for the country. The country will now have to give up more of its exports to obtain the same quantity of imports as before. Thus, the quantity of imports will decrease.
This decrease in the quantity of imports can have a negative impact on the level of wellbeing or satisfaction/utility in the country. A reduction in imports means that the country has access to fewer goods and services from abroad. This could lead to a decrease in consumer choice, higher prices for imported goods, and potential shortages of certain goods if they are not produced domestically. Overall, a decrease in imports can reduce the variety and availability of goods, potentially decreasing the overall level of wellbeing in the country.
(b) If the quantity of imports stays the same, but the price of Good I (exports) has stayed the same, the terms of trade have improved for the country. The country can now obtain more imports for the same quantity of exports. However, since the quantity of imports remains unchanged, the quantity of exports will also remain the same.
In terms of the level of wellbeing or satisfaction/utility in the country, this situation may not have a significant impact. While the country might be able to acquire relatively more imports for the same quantity of exports, the lack of increase in exports means that there won't be any additional income or resources generated from export growth. Therefore, any impact on the level of wellbeing will be limited as it depends on the overall state of the country's economy and the significance of international trade for its welfare.