In panel a, the reduction of Norway’s production possibilities away from fish cause the production of

fish relative to automobiles to fall. Thus, despite the higher relative price of fish exports, Norway moves

down to a lower indifference curve representing a drop in welfare.

imports it purchases. 4. The difference from the standard diagram is that the indifference curves

©2012 Pearson Education, Inc. Publishing as Addison Wesley

Chapter 6 The Standard Trade Model    25

5. The terms of trade of Japan, a manufactures (M) exporter and a raw materials (R) importer, is the world

relative price of manufactures in terms of raw materials (pM/pR). The terms of trade change can be

b. Korea’s increased automobile production increases the supply of manufactures, which increases

c. U.S. development of a substitute for fossil fuel decreases the demand for raw materials. This

increases world RD, and the world relative demand curve shifts out, increasing the world relative

d. A harvest failure in Russia decreases the supply of raw materials, which increases the world RS.

6. The declining price of services relative to manufactured goods shifts the isovalue line clockwise so

that relatively fewer services and more manufactured goods are produced in the United States, thus

reducing U.S. welfare.

7. These results acknowledge the biased growth which occurs when

there is an increase in one factor of production. An increase in the capital stock of either country

favors production of good X, while an increase in the labor supply favors production of good Y. Also,

© 2012 Pearson Education, Inc. Publishing as Addison-Wesley

Chapter 6 The Standard Trade Model    26

8. Immiserizing growth occurs when the welfare deteriorating effects of a worsening in an economy’s

terms of trade swamp the welfare improving effects of growth. For this to occur, an economy must

9. India opening should be good for the United States if it reduces the relative price of goods that

China sends to the United States and hence increases the relative price of goods that the United States

imports good B, while country Y exports good B and imports good A. The export subsidy in country

X will raise the internal price of the export good A, leading to an increase in production of good A

and decrease demand of good A. As a result, the world price of the good A falls. The tariff on good A

in country Y will increase production and decrease demand for good A in country Y, leading to a

reduction in the world price of good A relative to good B. Thus, the terms of trade in country X falls

and the terms of trade in country Y rise. Country X is worse off, while country Y is better off.

consumption in exchange for future consumption. In other words, these countries will borrow in the

current period from countries that have a relative preference for future consumption. Much like

international trade, the relative amount of current consumption that is traded for future consumption

is determined by the relative price of future consumption, defined as 1/(1  r), where r is the real

12. Comparative advantage in international borrowing and lending is driven by the relative price of future

consumption, and more specifically, the real interest rate. As the real interest rate rises, the relative price

of future consumption 1/(1  r) falls. Effectively, a country with a high real interest rate is one that has

high returns on investment. Such a country will prefer to borrow today and take advantage of the high

return on investment and enjoy the fruits of current investment with high returns in the future.

© 2012 Pearson Education, Inc. Publishing as Addison-Wesley

Chapter 6 The Standard Trade Model    27

a. Countries like Argentina and Canada should have high real interest rates as there are large

© 2012 Pearson Education, Inc. Publishing as Addison-Wesley