The Terms of Trade and Public Goods

The Terms of Trade and Public Goods

A model of a small open economy with a non-tradable public good and two tradable private commodities is employed to consider the implications of the terms of trade on the optimal quantity of a public good. First, the Samuelson condition is developed for this three good economy. Then the effect of a terms of trade change is decomposed into supply and demand side components. Observations are made regarding the influence of terms of trade improvements. The importance of including terms of trade considerations in determining the optimal amount of public goods and in explaining the size of government is emphasized. Some interesting implications for the size of government, in absolute and relative terms, are made for industrialized economies.