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Terms of Trade - acceptable to country 1 So long as this...

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Shomu Banerjee ECON 101 CALCULATING TERMS-OF-TRADE Suppose the blue PPF1 and the red PPF2 are the two production possibilities for two countries. From the slopes, one can infer that country 1 has a comparative advantage in good x while 2 has a comparative advantage in good y . If each specializes completely in the good in which they have a comparative advantage, they produce at the points shown by the red dots. In the left panel, I have also superimposed a red line (which has the same slope as PPF2) starting from country 1’s point of specialization. Any terms-of-trade (e.g., the one shown by the green line) that lies outside the blue PPF will be
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Unformatted text preview: acceptable to country 1. So long as this terms-of-trade is not steeper than the red line, it will also be acceptable to country 2. To see this, go to the right panel. In the right panel I’ve reproduced the green terms-of-trade line as well as a blue line which has the same slope as PPF1. This shows that the terms-of-trade line has to be flatter than the red PPF2 but less flat than the blue line. So a terms-of-trade that is acceptable to both has to lie between the slopes of the two countries’ PPFs. x x y y PPF1 PPF2...
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