This study focuses on the relationship between trade and relative prices of pollution intensive goods. Seminal to this idea is the transfer problem. It is based on the idea that environmental quality of two countries that engage in trade could be affected and this could also have possible environmental quality transfer effects in a third country (geographic neighbors or trade partners) and a result, terms of trade effects. The paper makes the case that whether the relative price of a pollutant would suffer during trade will depend on the kind of pollutant it is, distance between the countries involved, countries’ marginal propensity to consume and substitutability of the good. The nature of the pollutant (whether it is spatially separable in production and or consumption) determines whether it can spillover to trade neighbors or whether it is transferable to a trade partner with ramifications to its relative price. The paper uses indirect utility functions and compensated demand functions to analyze the terms of trade effects.
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