Let us assume the situation like in the lecture; the home country exports cloth and imports...

Let us assume the situation like in the lecture; the home country exports cloth and imports food. Please explain with graph(s)what will happen, if the relative price of food increases?

Particularly, derive

A What will happen with the slope of the iso-value line?

B What will happen with the production quantities in the home country (Will more or less food produced and will more or less cloth produced) ? Why?

C What will happen with the terms of trade of the home country?

D Will the home country be better or worse off, after the relative price of food increased? Why?

Expert Solution

Answer A- Maximum satisfaction arise where Indifference curve is tangent to the isovalue line. It is a point where export of cloth and import of food is equal to each other. It is a situation of maximum satisfaction due to

Exports = Imports.

But satisfaction decrease when imports of food increases and export of cloth do not increase.Iso value line shift to the left and now, satisfaction will decrease due to dependency on imports.

Answer - 2 With increase in the exports of cloth , amount of clothes will reduce in native country. With decrease in the exports of cloth , amount of clothes will rise in native country because of no supply in foreign market.

With increase in the import of food , amount of food will rise in native country. With decrease in the import of food , there will be shortage of food in native country.

Answer-3 Terms of trade is price to exports to price of imports.Export biased growth will reduce term of trade and the value of native currency While import biased growth will increase term of trade and the value of native currency.

Answer-4 With the increase in the price of food ,import will become costly and native nation will reduce imports and these leads towards the better situation for economic growth due to increase in output, productivity and employment .

Rahul Sunny answered 8 months ago

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