Task: Consider two large countries, A and B. A imports good x and exports goody, while B imports good y and exports good x.
(1) Using the Basic Trade Model, illustrate the distinct terms-of-trade effects of (i) import-biased growth in country A and (ii) export-biased growth in country A. All else equal, which kind of growth would the government of A like to foster if it seeks to increase the aggregate income of its economy? Which kind of growth would the government of B like A’s government to foster if the government of B seeks to increase the aggregate income of its economy?
(2) Now suppose that both A and B pursue their own growth policies in isolation (i.e., each government chooses whether to foster import-biased or export-biased growth while taking the choice of the other government as given). In light of your answer to part (a), comment on the likely efficiency properties of the resulting growth policies of the two governments from an international perspective (i.e., from the perspective of world aggregate income).