Income Effect, Wealth Effect, and the Terms of Trade with Finite Horizons.

The two-sector model is incorporated into Blanchard's OLG framework. The total effect of a terms-of-trade deterioration on aggregate savings is decomposed into an income effect and a wealth effect. The income effect comes about because a terms-of-trade deterioration changes the value of the GDP. Its sign depends on the value of the rate of time preference relative to the interest rate. The wealth effect comes about because financial wealth is insurable and so income from capital is discounted at a lower rate than labor income. Its sign depends on the relative factor intensities of the goods.