the Effect of Exchange Rate Changes (2)

As John Stuart Mill(1848) pointed out ,the equilibrium terms of trade will reflect the size and elasticity of determined by the resource endowments and technology.appropriate adjustment to demand conditions is provided in the classical model by the price-specie-flow mechanism if trade is not balanced between the two trading partners . the equilibrium terms of trade are thus realized by adjustments in the relative wage rates because of the movement of gold between the two countries . a country with a trade surplus will find gold flowing in,resulting in an increase in prices and wages.This will continue until wages have risen sufficiently to reduce its exports and increase its imports and trade is balanced between the two countries. the reverse will occur in the deficit country,The mechanism ensures that each country will export at least one good .
the general equilibrium nature of the Classical approach is formally presented in a well-known model by Rudiger Dornbusch,Stanley Fischer ,and Paul Samuelson (1977). they construct a multicommodity model between two countries that captures the relative supply conditions between the two countries and incorporates total (both countries) relative demand for the commodities under consideration.This enables them to demonstrate the simultaneously-determined links relative wage rates ,prices ,and exchange rates and to show clearly that wages and prices are jointly determined with trade when balanced trade between countries is achieved . the original model also incorporated transportation costs , traffic ,and nontraded goods .