Question

In a two-country Classical model of trade with many commodities, briefly explain what would happen to the structure of trade in each of the following cases:

(a) an increase in wages in one country
(b) a change in the exchange rate
(c) an improvement in productivity (lowering of the labor requirements/product) in one
country
(d) an increase in transportation costs.

Answer 1

(a)an increase in wages in one country

An increase in wages increases the cost of production for the firm producing it which forces the producers or sellers to raise the prices so that they do not lose profits.As the price rises,domestic as well as international consumers will buy less of it and thus less output will be produced.Since less output will be produced,hence less output will be sold in domestic market and similarly less output will be traded.

(b)a change in exchange rate

An exchange rate is the rate at which one currency will be exchanged for another.A currency can appreciate i.e. an increase in the value of one currency in relation to another currency or depreciate i.e. a decrease in the value of one currency in relation to another currency.Currency appreciation negatively affects the trade(exports) of a country as the goods of domestic country become expensive to foreigners and currency depreciation positively affects the trade(exports) of a country as the goods of domestic country become cheaper to foreigners.

(c)an improvement in productivity in one country

An improvement in productivity is a positive sign for any firm because it leads to production of more output while hiring same number of labourers as before.So in this case wages remain constant but producer gets more output to sell which will lead to increase in trade.

If a firm has a target output to be produced and productivity increases then it can produce the target output with less number of labourers which can reduce the amount of wages to be paid.So in this case output remains constant but cost of production decreases which will again lead to increase in trade.

(d)an increase in transportation costs

Transportation cost is the cost of moving produced goods from a factory or any place of production to a different location from where they can be easily offered to consumers.Increase in transportation costs increases the cost of production for the producers which force them to raise the prices.As price rises,domestic as well as international connsumers will demand less of it and thus less output will be produced.So less production means less output will be sold in domestic market and less output will be traded.