Suppose that in a year, an American worker can produce 100 shirts or 20 computers, while...

Output per Worker per year	U.S.	China
Shirts	100	100
Computers	20	10

1.Now allow American and China to trade with each other. Find a mutually agreeable trade that makes each country better off than it was before it specialized. What is the range of TOT at which trade can occur?

2. List the determinants of the terms of trade. What do factors affect the level of the terms of trade?

Solutions

Expert Solution

1) For U.S
100 S= 20 C
thus Opportunity cost for Shirts, S = (20/100) C = 1/5 C
and Opportunity cost for Computers, C = (100/20) S = 5S

Similarly, For China
100 S= 10 C
thus Opportunity cost for Shirts, S = (10/100) C = 1/10 C
and Opportunity cost for Computers, C = (100/10) S = 10S

Thus China has comparative advantage in production of Shirts as its opportunity cost is lower in comparison to US
Similarly, U.S has comparative advantage in production of Computers as its opportunity cost is lower in comparison to China

Thus the range of TOT at which trade can occur is 9S:1/6C

2) determinants of the term of trade are preferences, scarcity of the good, size of trade, quality of the traded good, policies of the government
factors affecting the level of term of trade are availability of substitutes in home country for the imported good, devaluation of the home currency, technological changes, tariffs imposed by the government also plays a major role

Rahul Sunny answered 2 weeks ago

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