International monetary theory and policy Graphically show ho

Graphically, show how intertemporal trade can be welfare increasing. Draw two graphs, one for the current account surplus country and the other for the deficit country.

Solution

Terms of trade refers to the price of exports relative to the price of imports. When a country exports cloth and the relative price of cloth increases, terms of trade rise. Higher relative price for exports means that a country can buy more imports, and an increase in the terms of trade increases a country’s welfare. A decline in terms of trade decreases a country’s welfare.

Current account surplus graph:

Current account deficit graph:

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