Suppose a developing country’s export supply curve is relatively inelastic.
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Draw a downward-sloping demand curve, and an upward-sloping but relatively steep supply curve. Label these curves “D” and “S.” Why might a developing country have an inelastic export supply curve?
Now suppose demand for this product increases. Draw this shift on your graph, labeling the new demand curve “D5”.
Is the price increase resulting from the increase in demand larger or smaller than it would have been if supply had been more elastic?
Now suppose a developing country faces a relatively inelastic demand curve for its exports.
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Draw an upward-sloping supply curve and a downward-sloping but very steep demand curve. Why might a developing country face an inelastic demand curve for its exports?
Now suppose supply for this product decreases. Draw this shift on your graph, labeling the new supply curve “S5”.
Is the price increase resulting from the increase in supply larger or smaller than it would have been if supply had been more elastic?
This exercise involves the debt-relief Laffer curve.
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Draw a graph similar to Figure 3 in the Appleyard, Field, and Cobb text. Label the horizontal axis “face value of debt” and the vertical axis “market value of debt.”
If lenders expect to be fully repaid, then the face value of debt would be equal to the market value of debt. Represent this with a 45-degree line in your graph.
Suppose that up to some level of debt, say $200 million, lenders expect to be fully repaid. Label this point on the 45-degree line “A.”
Suppose that above $200 million, lenders no longer expect to be fully repaid, and bonds issued by LDCs sell at a discount in secondary markets. In particular, suppose debt with a face value of $260 million sells for $220 million, and debt with a face value of $300 million sells for $230 million. Mark these two points “B” and “C,” respectively.
Finally, suppose that when debt levels rise above $300, a country’s repayment prospects become increasingly poor, and debt is very heavily discounted. Suppose that debt with a face value of $340 million has a market value of only $170 million. Label this point “D.”
If a developing country is located on the downward-sloping portion of the debt-reduction Laffer curve (that is, between points C and D), why might it make sense for lenders to agree to write off some of the debt?
