2. TERMS OF TRADE
• Determine the rate at which one country is willing to trade one
item for another item on the world market
• Trade terms may be expressed in either monetary or bartering
vocab
• As monetary expression, terms of trade are stated as a world price, the subject
of upcoming discussion
• When viewed from a bartering standpt, trade terms refer to the amt of certain
items 2 countries are willing to exchange w/ one another
• Trade terms are influenced by eco and non eco factors and must be
negotiated through a political process
• There is no unique set of optimal trade terms btwn 2 countries
• A range of aceptable trade solutions exists from which the countries must
select through trade agreements
• Knowing how a country benefits form specializing can help us determine how
it may benefit from trade- shifts PPC outward
3. SOLVING TERMS OF TRADE PROBLEMS
• If necessary, construct an output table using
the data for two nations- this reps their
production possibilities before trade
Item A Item B
Nation C 100 200
Nation D 40 200
4. CONTINUED…
• Determine the cost ratios and comparative
adv of each nation
• Select one product as a reference and use its
cost ration to determine its per-unit
opportunity cost for each nation
Item A Item B
Nation C 2* 1/2
Nation D 5 1/5*
Nation C: 1A= 2B …Nation C not willing to trade As for less than 2Bs apiece
Nation D: 1A= 5B.…Nation D not willing to trade As for more than 5 Bs apiece
5. CONTINUED…
• Set a term of trade somewhere btwn the two
boundaries
• 1A= XB where 2< X< 5
• Say 1A= 3B is negotiated as a trade term
• Calculate the max amt of each item each nation
can gain through trade
• Nation whose cost adv is item A should MULTIPLY its output
of that item by the term of trade
• Nation whose cost adv is item B should DIVIDE its output of
that item by the term of trade
– Nation C: 100A x (3B per A)= 300B
– Nation D: 200B / (3B per A)= 66 2/3A
6. CONTINUED….
• Plot the TPC for each nation and show the
gains from trade, if requires
Nation C Nation D
Gains from trade
Item A
Item B
TPC
PPC
300
200
100
Gains from trade
Item A
Item B
200
40 66 2/3
