Suppose Country A relies on exports of two primary products, sugar cane and rubber.a. According to the predictions of Engel's law, what will happen to the terms of trade of Country A in the long run?b If you are to provide economic policy advice to this nation's government, what advice would you give? In your answer, be sure to explain the reasons behind your advice.

Question

What will be an ideal response?

Answer 1

POSSIBLE RESPONSE:

a. Engel's law states that in the long run, with an increase in the per capita income, the relative demand for primary products will decline. Therefore, it can be predicted that with a decline in the relative prices of the primary products, the terms of trade of Country A would deteriorate.

b. Relying on exports of primary products may hold back the growth of a developing country. The country may try to form international cartels with other exporters of each product. However, a cartel may not work because the incentive to cheat will be high. In addition, it is important for a cartel to consider that, the higher the price elasticity of demand and the higher the price elasticity of non-cartel supply, the lower will be the price that they can set. The country instead should attempt to diversify its export base. The most promising path is probably to encourage production and export of products that exploit the country's comparative advantage, perhaps products that use less-skilled labor intensively in production.