International Trade with Fluctuating Prices

dian world in which the supply of a non-tradable consumer good is uncertain. Turnovsky [10] using the same two good linear production model, has analyzed the implications of technological uncertainty. The latter author also examines the case of a small country facing externally generated random fluctuations in the of trade. A less complete discussion of of uncertainty also appears in Ruffin [9]. Assuming that factors of production are mobile only prior to learning the value of the random parameter, a major focus of these papers is on the possibility of specialization reversals. For example, it is shown that there are conditions under which it is optimal to specialize in the good which would not be produced were the of to take on the expected value with certainty. However, in none of the above papers is there a systematic attempt to obtain conditions sufficient to determine either the allocational, or welfare implications of international price uncertainty. We will show in the following pages that there are indeed relatively weak conditions under which it is possible to derive such implications. The discussion proceeds under the assumption of a convex production technology including of course the Ricardian special case. While the model is extended to many goods in Appendix 3 we will, for expositional ease, consider a two good world in the text. The main body of the paper compares the optimal allocation when there are random fluctuations in the international prices of the two goods with the solution when the ratio of these prices w = P1IP2 or terms of trade takes on its expectation with certainty. This is extended to the case of mean preserving increases in price uncertainty in Appendix 2. Specifically it is shown that the optimal response to such uncertainty is to reduce the output of good 1 if risk aversion is sufficiently low. However, with higher risk aversion it becomes optimal to move away from highly specialized production and towards the production point which is optimal in the absence of possibilities. Unlike the general analysis of the implications of increasing risk by Rothschild