Reference no: EM132996202

Assume a standard trade model with two traded goods - food and machinery. Output of food (worldwide) is denoted by QF ; output of machinery is denoted by QM. The world price of food is PF . The world price of machinery is PM. The world market, i.e., relative supply and relative demand, is in general affected by exogenous shocks. The financial crisis and the Covid pandemic are two examples of such shocks.

Make the following assumptions about the two crises:

1. Financial crises: Demand and supply of food have not been affected. Supply of machinery has not been affected. Demand of machinery has been negatively affected.

2. Covid pandemic: Demand and supply of food have not been affected. Supply and demand of machinery have been negatively affected.

a) For each of the two crises, illustrate the effects of the crisis on the world market in a suitable diagram.

b) Discuss the effects of both crises on relative demand and relative supply and on the world market equilibrium (i.e., relative price and quantity).

c) For both crises, how has the crisis affected the terms of trade for exporters of food and exporters of machinery? Briefly explain.