Terms of Trade Vulnerability and National Welfare in a Small Open Economy.

This paper examines the implications of terms of trade vulnerability for a perfectly competitive, small open economy with incomplete risk markets. Conditions are obtained for which an improvement in the mean terms of trade raises welfare and for which an increase in the variance of the terms of trade reduces expected welfare. Whether the risky sector should be taxed or subsidized depends on the relative risk preferences of producers and consumers, upon relative marginal propensities to consume, and upon whether the economy is a net exporter or importer of the risky good. Copyright 1990 by Royal Economic Society.