Alfonso Llanes, studied at Florida International University
The short answer is that it all comes down to the terms of trade. Terms of trade (TOT) indicates the relative price of imports in terms of exports and is defined as the ratio of export prices to import prices (landed price) excluding transportation cost, taxes and border crossing duties.
The Singer–Prebisch thesis works with different negotiating positions of labor in developed and developing countries. As a result, the hypothesis was prevalent in the 1960s and 1970s with neo-Marxist economists which provided a rationalization for the expansion of the role of the commodity futures exchange as a tool for development.
The ideas posed by economics of development introduced the “Modernization theory” of development which states that all societies progress through comparable periods of development. It follows that today’s underdeveloped areas of the world are in the same path that developed areas of the world had to trek in their past. The task at hand was therefore; help the underdeveloped areas with investments and technology transfer to accelerate the transition to global market integration.
The “Dependency theory” arose as a reaction to the modernization theory as the notion that resources flow from a "peripheral" of poor and underdeveloped regions to a "center" of wealthy nations, enriching the latter at the expense of the former. This is the basic assumption that is fundamental to the contention of the dependency theory “poor states are impoverished and rich ones enriched by the way poor states are integrated into the "world system".
On the other had the dependency theory also argues that underdeveloped countries are not merely primitive versions of developed countries, but have unique features and structures of their own. Dependency theory no longer has many proponents as an overall theory, but some observers have argued for its continuing relevance as a conceptual orientation to the global division of wealth.
A common account for this economic behavior is that manufactured goods have a greater income elasticity of demand than primary products, especially food. Therefore, as incomes increase, the demand for manufactured goods rises more rapidly than demand for primary products. In addition, primary products have a low price elasticity of demand, so a decline in their prices tends to reduce revenue even when sales volume increase it does not reflect on capital gains.
In basic microeconomics, the terms of trade are usually set in the interval between the “opportunity costs” for the production of a given good of two countries whether primary, semi-manufactured or manufacture products.
An improvement of a nation's terms of trade benefits that country in the sense that it can buy more imports for any given level of exports. Nevertheless, terms of trade are also influenced by the exchange rate because a rise in the value of a country's currency lowers the domestic prices of its imports but may not directly affect the prices of the commodities it exports. (Currency manipulation)
In the simplified case of two countries and two commodities, terms of trade is defined as the ratio of the total export/import commodity to the total export revenue it pays for its import commodity. In this case, the imports of one country are the exports of another country. For example, “if a country exports 100 dollars' worth of product in exchange for 100 dollars' worth of imported product, that country's terms of trade are 100/100 = 1. The terms of trade for the other country must be the reciprocal (100/100= 1). When this number is falling, the country is said to have deteriorating terms of trade. If a country's terms of trade fall from 100/80= 0.8, it has experienced 20% deterioration in its terms of trade. When doing a time series calculations, it is common to set a value for the base year in order to make interpretation of the results easier to evaluate.
Terms of trade do not reveal the volume of the countries' exports, only relative exchanges between countries. To understand how a country's social utility is affected, it is necessary to include changes in volume of trade, productivity, resource allocation, and direction of capital flows.
The notion of Pareto efficiency has been used in engineering quite often. It states that given a set of choices and a way of valuing them, the Pareto frontier is the set of choices that are Pareto efficient. By restricting attention to the set of choices that are Pareto-efficient, a designer can make trade offs within this set, rather than considering the full range of every parameter in the set.
It would be incorrect to treat Pareto efficiency as equivalent to societal optimization, as the latter is a normative concept that is a matter of interpretation that would account for the degrees of inequality of distribution. Generally, more equal distribution occurs with the help of government redistribution of wealth.
A Pareto efficiency does not require a totally equitable distribution of wealth in an economy in which wealthy elites hold the vast majority of resources can still be Pareto efficient. This distribution of wealth within the status quo is Pareto efficient regardless of the degree to which wealth is equitably or not being distributed.
A simple illustration of this concept is to divide pie among three people where the most equitable distribution would to assign one third to each person. Nonetheless, assigning a half section to each of two individuals and none to the third is also Pareto optimal despite the fact of not being equitable. In this scenario, none of the recipients could be made better off without decreasing someone else's share; and there are many other such distribution scenarios to choose from.
A Pareto inefficient distribution of the same pie would be to allocate a quarter of the pie to each of the three persons with the remainder quarter discarded. The origin and value of the pie is considered irrelevant in these cases, whereby an individual gained is made while none of the beneficiaries contributed to it in anyway i.e., land, inherited wealth, a tax cut to a selected group in a society and so on as the criterion of Pareto efficiency does not regulate a unique optimal allocation. For instance wealth consolidation may exclude others from wealth accumulation because of impediments to market entry, etc.
Other methods for studying resource allocation in a society include the partial equilibrium analysis where the determination of the price of a good is simplified by just viewing the price of one good, and assuming that the prices of all other goods remain fixed. The Marshallian theory of supply and demand is a good example of partial equilibrium analysis when the first-order effects of a shift in the demand curve do not shift the supply curve as if one was independent from the other.
Continental European economists made important advances towards a broad “General equilibrium theory” one of them being Leon Walras who introduced the tâtonnement process which translates from French as a "trial and error model.” Walras' proofs of the existence of general equilibrium theory in economics were often based on the counting of equations and variables which are inadequate for non-linear systems of equations.
Walras also proposed a dynamic process by which general equilibrium might be reached, that of the attunement or groping process for investigating stability of equilibra. Prices are announced in this case by an "auctioneer" and agents which state how much of each good they would like to offer or purchase and a given price (supply and demand). According to Walras, no transactions and no production take place at disequilibrium prices. Instead, prices are lowered for goods with positive prices and excess supply. Prices are raised for goods with excess demand. What happens in such process terminates in equilibrium where demand equals supply of goods with positive prices and demand does not exceed supply for goods with a price of zero. Walras was not able to provide a definitive answer to this question.
General equilibrium is designed to investigate such interactions between markets. The modern conception of general equilibrium is provided by a model developed jointly by Kenneth Arrow, Gérard Debreu, and Lionel W. McKenzie in the 1950s.
Three important interpretations of the terms of the theory have been often cited:
1.-Commodities are distinguished by the location where they are delivered making the Arrow-Debreu model a spatial model of as in the case of international trade.
2.-Commodities are distinguished by the time when they are delivered. The Arrow–Debreu model of intertemporal equilibrium contains forward markets for all goods at all dates. No markets exist at any future dates.
3.-Commodity contracts specify states of nature which affect when and how a commodity is to be delivered: "A contract for the transfer of a commodity specifies, in addition to its physical properties, its location and its date, an event on the occurrence of which the transfer is conditional.”
These interpretations are not exclusive of each other and can be combined. The complete Arrow–Debreu model applies to when, where and how goods are to be delivered. Therefore, there would be a complete description and set of prices for each contract: For instance 25 Metric Tons of winter red wheat, delivered on river elevator on 1st week of August in Minneapolis, if there is a hurricane in New Orleans during the summer months. A general equilibrium model of this sort appears to be a long way from describing the workings of trade economics, however, it is argued that it is useful as a simplified guide of how a real economy function under the general equilibrium model describing the workings of the complex economics of trade.
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