Trade Balance, Demand and Supply

Question 1

BT curve

Answer 1

Balance of trade curve plotted in q, y space. DEMAND SIDE

Above the curve, a trade surplus as q is depreciated.
(x > m)

Below the curve, a trade deficit as q is appreciated.
(x < m)

Along the curve, trade is in balance.

Question 2

Volume and Terms of trade effect

Answer 2

Following a depreciation:

Volume effect: Exports become more competitive and BT improves.

Terms of trade effect: Imports become more expensive and BT worsens.

Question 3

Marshall Lerner Condition

Answer 3

This determines whether the volume or terms of trade condition holds.

Volume effect > terms of trade effect.

As long as the sum of PED for exports and imports exceeds one, a depreciation will improve the terms of trade.

Question 4

Vertical and Downward Sloping ERU

Answer 4

ERU is vertical if wage setters define the real wage using the domestic price level.

ERU is downward sloping if wage setters use the full basket of goods (including imports), to determine the price level, and set their wage demands accordingly. (w= W/Pc).

Downwards sloping ERU means demand shocks affect output.