Suppose that country I's income elasticity of demand for imports (YEM) is 0.8. This YEM means that, as country I's national income rises, the "overall" or "net" effect of its growth on its trade sector is an __________ overall or net effect. In the context of the offer curve diagram, if country I is a "large" country and it grows (and assuming no growth occurs in its trading partner), this type of net effect means that country I's terms of trade, other things equal, will __________.

Question

Quizplus · Accepted Answer

A YEM of 0.8 means that as country I's income rises by 1%, its imports will rise by 0.8%. This indicates that country I has a relatively high demand for imports and is likely to import more as its income increases. In the context of the offer curve diagram, if country I is a large country and it grows (and assuming no growth occurs in its trading partner), this increase in demand for imports will lead to an increase in its import supply, causing the terms of trade to deteriorate (fall). Therefore, the correct answer is D.

Suppose That Country I's Income Elasticity of Demand for Imports