CH04

CHAPTER F O U R
4 International
Economics
Tenth Edition
Demand and Supply, Offer Curves,

and the Terms of Trade
Dominick Salvatore
John Wiley & Sons, Inc.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Learning Goals:
 Show how the equilibrium price at which

trade takes place is determined.
 Show how the equilibrium price at which
trade takes place is determined with offer
curves.
 Explain the meaning of the terms of trade and
how they have changed over time for the
United States.
Introduction
 Relative commodity price differences

between two nations in isolation reflect
comparative advantage, and forms basis for
mutually beneficial trade.
 Can use partial and general equilibrium

analysis to determine equilibrium-relative
commodity price at which trade will take
place.
The Equilibrium-Relative Commodity Price
with Trade-Partial Equilibrium Analysis
Supply, Demand, and Trade in a Single Industry
Let’s construct a model analyzing international trade in a

single market, say that of wheat.
Suppose that in the absence of trade the price of wheat in

Nation 1 is lower than that in Nation 2.
 With trade, Nation 1 will export: construct an export

supply curve.
 With trade, Nation 2 will import: construct an import

demand curve.
Supply, Demand, and Trade in a Single Industry (Cont.)
An export supply curve is the difference between the

quantity that Nation 1’s producers supply minus the
quantity that Nation 1’s consumers demand, at each
price.
An import demand curve is the difference between the

quantity that Nation 2’s consumers demand minus the
quantity that Nation 2’s producers supply, at each price.
Supply, Demand, and Trade in a Single Industry (Cont.)
In equilibrium,
import demand (MD) = export supply (XS)
 Nation 2’s demand – Nation 2’s supply =

Nation 1’s supply – Nation 1’s demand
 Nation 1’s demand + Nation 2’s demand =

Nation 1’s supply + Nation 2’s supply
 world demand = world supply

FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade
with Partial Equilibrium Analysis.
 Figure 4-1:
 At a relative price greater than P1, Nation 1’s excess
supply of X (Panel A) gives rise to Nation 1’s
international supply curve of X (S in Panel B).
 At a relative price lower than P3, Nation 2’s excess
demand for X (Panel C) gives rise to Nation 2’s
demand for imports of X (D in Panel B).
 Only at P2 (Panel B) does quantity of imports
demanded equal quantity of exports supplied.
 Thus P2 is equilibrium-relative commodity price
with trade.
Offer Curves
 Offer curves (sometimes called reciprocal demand

curves) introduced to international economics by
Marshall and Edgeworth.
 Show how much of its import commodity a nation
demands for it to be willing to supply various
amounts of its export commodity.
 Can be derived from production possibilities
frontier, indifference map and various
hypothetical relative commodity prices at which
trade could take place.
FIGURE 4-3 Derivation of the Offer Curve of Nation 1.
FIGURE 4-4 Derivation of the Offer Curve of Nation 2.
with Trade-General Equilibrium Analysis
 Equilibrium-relative commodity price with

trade found at intersection of offer curves for two
nations.
 Only at this equilibrium price will trade be
balanced.
 At any other relative commodity price, quantities
of imports do not equal quantities of exports,
placing pressure on relative commodity price to
move toward equilibrium.
FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade.
Relationship between General and Partial
Equilibrium Analyses
 Both partial equilibrium and general equilibrium

analysis use production frontiers and
indifference maps to find equilibrium trade price.
 Only general equilibrium analysis considers all
markets together, not just the market for
commodity X.
 Changes in the market for X affect other markets,
which possibly impact the market for X.
 General equilibrium analysis is therefore
required for more complete analysis.
FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial
Equilibrium Analysis.
The Terms of Trade
 Terms of trade = the ratio of the price of a

nation’s export commodity to the price of its
import commodity.
 In a two-nation world, the terms of trade of Nation 1
are equal to the reciprocal of the terms of trade of
Nation 2.
 In a world of many traded goods, the terms of trade is
the ratio of the export price index to the import price
index, also called commodity or net barter terms of
trade.
 If Nation 1 exports X and imports Y, its terms of trade are
given by PX/PY, where P = price index.
Terms of Trade
An improvement in a country’s terms of trade are

typically viewed as beneficial.
 An improvement in the terms of trade indicates

that fewer export goods will need to be provided
to purchase the same number of import goods.
Case Study 4-1 Demand, Supply, and the
International Price of Petroleum
Case Study 4-2 The Index of Export to Import
Prices for the United States
Figure 4.2 Index of Relative U.S. Export Prices, 1972-2011

(2000=100)
Case Study 4-3 The Terms of Trade of the G-7
Countries
Case Study 4-4 The Terms of Advanced and
Developing Countries
The Terms of Trade (cont.)
The Terms of Trade and the Prebisch-Singer Thesis

Concept of Terms of Trade
 Ratio between the export and import price indexes,
Px/Pm
 The terms of trade are said to deteriorate for a country
if this ratio falls.
Total export earnings depend on: total volume of exports

sold AND price paid for exports.
Historically, the prices of primary goods have declined

relative to manufactured goods.
The Terms of Trade and the Prebisch-Singer Thesis (Cont.)

 As a result, the terms of trade have on the average
tended to worsen over time for the non-oil-exporting
countries.
 Prebisch and Singer argue that export prices fall over
time, so LDCs lose revenue unless they can continually
increase export volumes.
 Prebisch and Singer think LDCs need to avoid a strong
dependence on primary exports.
 East Asian tiger economies (Korea, Taiwan, Hong Kong,
Singapore), China and India

CH04

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH04

Uploaded by

Copyright:

Available Formats

CHAPTER F O U R

Demand and Supply, Offer Curves,

 Show how the equilibrium price at which

 Relative commodity price differences

 Can use partial and general equilibrium

Let’s construct a model analyzing international trade in a

Suppose that in the absence of trade the price of wheat in

 With trade, Nation 1 will export: construct an export

 With trade, Nation 2 will import: construct an import

Supply, Demand, and Trade in a Single Industry (Cont.)

An export supply curve is the difference between the

An import demand curve is the difference between the

import demand (MD) = export supply (XS)

 Nation 2’s demand – Nation 2’s supply =

 Nation 1’s demand + Nation 2’s demand =

 world demand = world supply

 Offer curves (sometimes called reciprocal demand

 Equilibrium-relative commodity price with

 Both partial equilibrium and general equilibrium

 Terms of trade = the ratio of the price of a

An improvement in a country’s terms of trade are

 An improvement in the terms of trade indicates

Figure 4.2 Index of Relative U.S. Export Prices, 1972-2011

The Terms of Trade and the Prebisch-Singer Thesis

Total export earnings depend on: total volume of exports

Historically, the prices of primary goods have declined

The Terms of Trade and the Prebisch-Singer Thesis (Cont.)

You might also like