In the basic Classical model, only the limits to the international terms of trade can be specified. If the two country-two commodity model is monetized using an exchange rate and a wage rate for each country, the international terms of trade are implicitly specified. Explain why this is so.

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The Answer is In the basic Classical model of international trade, often associated with David Ricardo's theory of comparative advantage, the terms of trade between two countries are determined by the relative costs of production of two commodities. The limits to the international terms of trade are set by the opportunity costs in each country. The terms of trade must lie between the opportunity costs of the two countries for trade to be mutually beneficial. However, the exact terms of trade within these limits are not specified by the model itself.

When the model is monetized, meaning that we introduce an exchange rate and wage rates for each country, the international terms of trade become more explicitly defined. Here's why:

1. **Exchange Rate**: The exchange rate is the price at which one currency can be exchanged for another. It allows us to convert the cost of goods from one country's currency into another country's currency. By establishing an exchange rate, we can compare the prices of goods between countries directly. This comparison gives us a clearer picture of the terms of trade because we can now express the value of exports in terms of the value of imports directly.

2. **Wage Rate**: The wage rate is the amount of money paid per unit of labor. In a monetized model, the wage rate reflects the cost of labor in each country. Since labor is a significant component of production costs, knowing the wage rates helps to determine the cost of producing each commodity in each country. When we know the production costs, we can better estimate the prices at which countries will be willing to trade.

By introducing these monetary factors, we can calculate the international terms of trade more precisely. The terms of trade, in this case, would be the ratio of the exchange rate-adjusted price of the commodity from one country to the exchange rate-adjusted price of the commodity from the other country. This ratio would implicitly reflect the relative wage rates and productivity levels of the two countries, as well as the exchange rate between their currencies.

In summary, monetizing the two country-two commodity model by including exchange rates and wage rates allows for a more explicit specification of the international terms of trade. It does so by providing a direct method for comparing the costs and prices of goods between countries, which are influenced by the exchange rate and the cost of labor as reflected in wage rates. This leads to a more precise understanding of at what rate the goods will be exchanged internationally.

In the Basic Classical Model, Only the Limits to the International