Question

International Economics

1. How does growth affect production according to the Rybczynski theorem? Is country size (“small” or “large” in trade) important for this result?

2. How can growth lead to a deterioration in the terms of trade for the large country? Can growth ever improve a country’s terms of trade? If so, when?

3. Explain how the change in the terms of trade accompanying growth can leave a country worse off after growth compared with its state of well-being prior to growth.

Answer 1

The theorem states that increase in the supply of one factor of production will increase output of the good using that factor , other things remaining unchanged.The production of the good not using that factor will decrease.AS for eg if the supply of labor increases , production of cloth which uses labor intensive methods will increase and production of steel which uses capital intensive method will decrease.If the country is large the country's import and export have more share in world market than a small country.If the country uses labor intensive technique than the country will be small and for capital intensive system it will be large.

Terms of trade is the ratio of export and import prices. If TOT is greater than 100%, the country is having more exports than imports.An increase in the TOT of the country shows that export prices have increased and import prices have fallen.There was increase in the TOT of developing countries in 2000's when prices of consumer goods increases but with globalization and growth , prices of manufactured goods fell .So TOT of developed countries fell with growth.Growth can improve a country's terms of trade if for every unit of exports it can buy more unit of imports.So there will be rise in the terms of trade and will lead to fall in import prices relative to export prices.

Worse terms of trade means a country has to export more to increase its imports . This happens when there is fall in the commodity prices in relation to prices of manufactured goods .This has happened in many developing countries