Question

Use the standard trade model to show how export-biased growth lowers a country's terms of trade. Using two diagrams of the country's PPF, show how the export-biased growth can lead to either an increase or a decrease in the welfare of the country.

Answer 1

We know that one country can't produce all the things they needed,so it only produces those goods those he could produce better than the other countries and export it to other countries.and in exchange they import all the things they needed but can't produce efficently.this is the basic concept of trade.and price ratio at which trade is occurs between the two countries is called terms of trade.now from export any country earns foreign currencies which help them in many issues like to pay it for imports and others and to improve the government balances.so all the countries try to export more and more to expand their economy.but it not always work in that way what the country thinks.sometimes export-biased growth leads to a lower country's terms of trade.but how is it possible...lets see if any country produce more and more export goods then there can be over production of that particular goods but the demand is not increases so the price will fall for the exporting goods but the price of the importing goods is remains the same so the terms of trade is decrease for the exporting country which means now it has to export more goods for the one amount of importing goods.other things can be happen when export biased growth happens then the cost of production is lower than before and the price will became less.on the other hand to give more focus on exporting goods only the country doesn't produce some essential goods that must be produced in home country but to import those things it has to bear higher costs which also lowers the country's terms of trade.

We can also explain it with a figure.we assume that there are two country A and B.A produces X and export it to B,on the other hand B produces Y and export it to A.now A's export is B's import and B's export is A's import.so basically there are two commodities X and Y are exchanged.here in the above fig we plot X on the vertical axis and Y on the horizontal axis.here we can see X's 1unit is exchanged with Y's 2 unit.so the terms of trade for country B is Y/X which is 2.that means country B has to give 2 unit of Y to get 1 unit of X.now suppose Y's quantity increased.now if for the 2nd amount of X country B has to sacrifice 5 amount of Y which is greater than before.and furthur increase to the 3rd amount of X needed 9 amount of Y.here to get 1 amount of X he has to sacrifice average 3amount of Y.which clearly shows that decrease in the welfare of the country