International Economics 9th Edition Appleyard Solutions Manual

International Economics 9th Edition
Appleyard Solutions Manual

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CHAPTER 7
OFFER CURVES AND THE TERMS OF TRADE
Learning Objectives:
■ Describe a country’s offer curve and show how it is obtained.

■ Identify how the equilibrium international terms of trade are attained.
■ Explain how changes in both supply and demand conditions influence a country’s
international terms of trade and volume of trade.
■ Illustrate how different elasticities on the offer curve affect the impact of economic
changes.
■ Demonstrate the usefulness of different concepts of the terms of trade.
I. Outline
Introduction
- Terms-of-Trade Shocks
A Country’s Offer Curve
Trading Equilibrium
Shifts of Offer Curves
Elasticity and the Offer Curve
Other Concepts of the Terms of Trade
- Income Terms of Trade
- Single Factoral Terms of Trade
- Double Factoral Terms of Trade
Summary
Appendix A: Derivation of Import-Demand Elasticity on an Offer Curve
Appendix B: Elasticity and Instability of Offer Curve Equilibria
II. Special Chapter Features
Concept Box 1: The Tabular Approach to Deriving an Offer Curve

Concept Box 2: Measurement of the Terms of Trade
In the Real World: Terms of Trade for Major Groups of Countries, 1973-2013
In the Real World: Income Terms of Trade of Major Groups of Countries, 1973-2013
III. Purpose of Chapter
The purpose of this chapter is to introduce students to the concept of the offer curve and
to the determination of the equilibrium international terms of trade. A general overview of the
chapter is that, until this point in the book, the establishment of the equilibrium terms of trade
has not been analyzed: now the student can see how the terms of trade result from the interaction
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of supply and demand in the world market.
IV. Teaching Tips
A. Offer curves are often viewed by students as difficult and theoretical. The introduction to
this chapter presents the impact of changes in the supply of exports or demand for imports on
terms of trade for a group of African nations. The impact of these changes in terms of trade on
real income is also presented. This is designed to provide additional motivation for the students
to understand how terms of trade are determined and why they change.
B. The offer curve and the terms of trade are used extensively in later chapters, so the
foundation established in this chapter is very important. We find it useful to stress that, unlike
other concepts to which the students have been exposed, the offer curve is both a supply curve
(of exports) and a demand curve (for imports).
C. The “tabular approach” to deriving an offer curve developed in Concept Box 1 seems to
be interesting to students. It is also useful because it drives home the point about the offer curve
being both a supply curve and a demand curve. In addition, adding another row or two to the
table with appropriately-chosen numbers can yield a “backward-bending” offer curve that is
understandable.
D. The nature of the shifts in Country II’s offer curve discussed and illustrated on page 108
should be emphasized. For some unknown reason, students often seem to think that an
“increased willingness to trade” by the country whose exports are on the vertical axis means a
pivot of that country’s curve downward and to the right.
E. The use in class of the latest export and import price data from the IMF’s website
www.imf.org (or http://data.imf.org) to demonstrate calculation of the commodity terms of trade
seems to be of interest to students.
F. We’ve never quite puzzled out why, but some students often seem to confuse “terms of
trade” with “balance of trade.” It is useful to distinguish between these very different concepts.
V. Answers to End-of-Chapter Questions and Problems
1. A change in tastes by the home country’s consumers toward greater relative preference
for the import good would increase the willingness of the country to trade. In addition, a rise in
income (provided that imports as a whole are not “inferior goods”) would also make the country
more willing to trade at each terms of trade. Other events leading to greater willingness to trade
would be, for example, increased productivity in the export industry and trade negotiations that
resulted in a lowering of trade barriers by the home country.
2. If the demand increase for the export good is by the foreign country, the terms of trade
will improve by an equal amount in either instance. If the country is large, the normal upward
64
shift in the foreign offer curve occurs; if the country is small, the straight-line offer curve by the
foreign country pivots to higher terms of trade for the home country. If the demand increase for
the export good is by home country citizens, the home country’s offer curve pivots inward. If the
country is large, the terms of trade will improve, but, if the home country is small, there will be
no impact on the terms of trade since a small country faces a foreign offer curve that is a straight
line from the origin.
3. The terms of trade for country I will definitely deteriorate, since both shifts are working
in that direction. However, the impact on the volume of trade is indeterminate without more
information. Assuming that country I is operating in the “elastic” portion of its offer curve, the
increased willingness to trade by I will lead to an expansion of both its exports and imports (if
country II is operating on the “elastic” portion of II’s curve) and to an expansion of I’s exports
and a contraction of I’s imports (if country II is operating on the “inelastic” portion of II’s curve).
The reduced willingness to trade by country II will lead to a contraction of both the exports and
imports of country I regardless of the elasticity range of II’s curve. The net effect on I’s exports
is indeterminate always and depends on the relative extent of the offer curve shifts; the net effect
on I’s imports is indeterminate if country II is operating in its “elastic” range and a decline if II is
operating in its “inelastic” range. If country I is operating in the “inelastic” portion of its offer
curve both before and after the two shifts, the result will be a greater volume of exports by I if
II’s curve is “elastic” but export volume could be less if II is in its “inelastic” range; the volume
of I’s imports can either increase or decrease with either range of II’s curve. (We assume that the
equilibrium positions are “stable” equilibria and, of course, that both countries are “large”
countries. You may also wish to assume for your class, as we usually do, that both countries
always operate in the “elastic” ranges of their offer curves, which makes the answers to this
question and to Question #4 below considerably simpler.)
4. With both countries operating in the “elastic” ranges of their offer curves, the volume of
country I’s exports and imports will definitely decrease. However, the terms of trade impact
(under all elasticity assumptions) is indeterminate without more information. Country I’s
decreased willingness to trade will improve its terms of trade, but country II’s decreased
willingness to trade will cause deterioration in I’s terms of trade. The net impact therefore
depends on the relative extent of the offer curve shifts. If country I is operating in the “inelastic”
portion of its offer curve, the volume of its imports decreases but the volume of its exports can
increase if country II is in its “elastic” range. If country II is also operating in the “inelastic”
portion of its offer curve, the volume of I’s exports will decrease but the volume of I’s imports
can actually increase.
5. The excess supply of exports of one good (say good X) means that, at the given terms of
trade, one country (say country I) is willing to provide a greater quantity of good X on the world
market than country II is willing to purchase at those terms of trade. PX/PY (with Y being II’s
export good) is thus higher than the equilibrium terms of trade. Because PX/PY is “too high,” this
must mean that PY/PX is “too low” or below the equilibrium level. A relative price of good Y
below the equilibrium level means that there is excess demand for good Y. Alternatively,
65
because a supply of exports reflects a demand for imports in the offer curve analysis, a supply of
good X from I that exceeds the demand for good X by II must be associated with a demand for
good Y by I that exceeds the supply of good Y coming forth from country II at the given terms of
trade.
6. In the offer curve diagram below, the initial trading equilibrium between Iraq and the rest
of the world (ROW) results in terms of trade TOT1. With the greatly reduced willingness to
trade by ROW, the ROW offer curve shifts downward to ROW’. The terms of trade for Iraq
deteriorate to TOT2, and the volume of Iraq’s exports and imports falls dramatically. If Iraq is in
the “inelastic” portion of its offer curve both before and after the ROW curve shift, Iraq could
actually end up exporting a larger volume, but this situation is highly unrealistic.
7. With relatively slow growth in demand for developing countries’ products by developed
countries, the developed countries’ offer curve shifts only slightly upward. With relatively rapid
growth in demand by the developing countries for developed countries’ export goods, the
developing countries’ offer curve shifts rightward to a relatively large extent. The terms of trade
deteriorate for the developing countries. If it were postulated that the developed countries were
in the “inelastic” range of their offer curve, the developing countries would experience an even
greater deterioration in their terms of trade. (It is highly unlikely that the developing countries
have an inelastic demand for developed countries’ goods, so that case does not need to be
considered.)
66
8. The offer curves of the oil-importing countries were likely inelastic because the rise in the
price of oil exports by OPEC resulted in greater “revenue” (export quantity in the offer curve
diagram) being spent on the crude petroleum imports by any given importing country. Hence,
the oil importers were in the “backward-bending” portions of their offer curves.
9. “Behaving rationally” occurs even with a “backward-bending” offer curve. The

underlying economic purpose of exports is to obtain imports for enhancing utility, and a rise in
the relative price of exports constitutes a fall in the relative price of imports. With this fall in the
price of imports, there will rationally be a rise in the quantity of imports purchased, and the
exporting country will export a smaller quantity if the demand for imports is inelastic.
Alternatively, the rise in the price of exports would lead to the export of a smaller quantity if the
“income effect” (or “terms-of-trade effect”) of the price increase outweighs the “production
effect” and the “substitution effect.”
10. The commodity terms-of-trade ratio for 2015 is 92.3 [= (120/130)⋅100]; the income terms
of trade for 2015 are 106.2 [= (120⋅115)/130]. Thus the commodity terms of trade deteriorated
from 2005 to 2015 while the income terms of trade improved. This could certainly occur if the
relative decline in export prices stimulated an elastic response of quantities demanded of the
country’s exports.
VI. Sample Exam Questions
A. Essay Questions
1. Suppose that a home country is contemplating the imposition of a tariff in order to

improve its terms of trade by a given amount. How would the decision as to the size of the tariff
to impose depend on the elasticity of the foreign country’s offer curve? Explain.
2. Suppose that, from an initial equilibrium position in the offer curve diagram, country I
imposes a tariff on country II’s export good at the same time that consumers in country II change
67
their tastes toward wanting more of II’s export good. Illustrate and explain the impact of these
two simultaneous events on country I’s volume and terms of trade. (Assume that both countries’
offer curves are “elastic” throughout.)
3. When Spain and Portugal joined the European Community (EC) in 1986, the United
States feared that a result of this change might be a shift in demand for agricultural products by
Spain and Portugal away from the United States and toward other Community members. In
response, the United States threatened to impose stiff tariffs on a variety of exports of the rest of
the EC to the United States. Using offer curve diagrams for (a) the United States and Spain/
Portugal, (b) Spain/Portugal and the rest of the EC, and (c) the United States and the rest of the
EC, illustrate and explain the effects of these potential events on the terms of trade and volume of
trade for the various economic units.
4. Given the following table showing possible terms of trade for country I and country I’s
corresponding demand for imports of good Y at each terms of trade:
possible terms I’s quantity demanded

of trade of imports of Y
(a) 1X:1Y or PX/PY = 1 20 units
(b) 1X:2Y or PX/PY = 2 46 units
(c) 1X:3Y or PX/PY = 3 69 units
(d) 1X:4Y or PX/PY = 4 84 units
Calculate the supply of exports of good X by country I at each terms of trade and plot the
resulting offer curve. What is the nature of the elasticity of demand for imports between [i]
points (a) and (b); [ii] points (b) and (c); and [iii] points (c) and (d)? How do you know? What
might account for these respective elasticities?
5. Given the following indexes for country I in 2015, with 2010 = 100:
price of exports = 108 quantity of exports = 116

price of imports = 120 quantity of imports = 102
(a) Calculate country I’s net barter or commodity terms of trade for 2015 (round to
nearest one decimal place if necessary).
(b) Calculate country I’s income terms of trade for 2012 (round to nearest one decimal
place if necessary).
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(c) Explain your differing results for (a) and (b) and briefly explain the significance of
each terms-of-trade movement for country I.
6. “If we observe that a home country’s volume and terms of trade are both moving
in the same direction (i.e., either both increasing or both decreasing), then we can
surmise that the home country’s offer curve is shifting. However, if we observe
that the home country’s volume and terms of trade are moving in opposite
directions (i.e., one is increasing and the other is decreasing), then we can surmise
that the foreign offer curve is shifting.”
Is this statement correct or incorrect? Illustrate and explain your answer. (Assume
“elastic” offer curves throughout.)
7. (a) Define the “offer curve” (or “reciprocal demand curve”) of a country. If an offer
curve is drawn as an upward-sloping curve, what is being assumed about the value of the
country’s elasticity of demand for imports and why does this assumption yield the
upward-sloping curve?
(b) Using the usual two-good, two-country offer-curve diagram, identify the equilibrium
position and state why the position is one of equilibrium. Then suppose that, from this
initial equilibrium position, one country now experiences an increase in productivity in its
export industry at the same time that the other country imposes an import tariff. Illustrate
and explain the combined or overall impact of these two events on the equilibrium terms
of trade and on the quantity traded of each of the two goods. If a combined impact is
uncertain, briefly indicate why it is uncertain.
8. (a) Define the theoretical concept of a country’s “offer curve” (or “reciprocal demand
curve”). Then, using a numerical example, construct three points on a country’s offer
curve, assuming that the country (call it “country A”) exports wheat and imports clothing.
(b) Put the offer curve of country A [you do not need to use your specific numbers from
part (a) of this question in this part (b)] together with the offer curve of trading partner
country B. Explain how the equilibrium position is attained if the countries initially are
in a situation that is not a position of equilibrium. (You can assume that the countries are
always operating in the “elastic” portions of their offer curves.)
(c) Finally, suppose that country B’s consumers change their tastes so that they now have
greater preference for country A’s export good than they did previously. Illustrate and
carefully explain the movement from the old equilibrium position to the new equilibrium
position because of this change in tastes, assuming other things equal. Be sure to include
an indication of the impact on country A’s terms of trade and volume of trade.
9. (a) Define the concept of a country’s (call it country A’s) offer curve. Will this curve
69
always be upward-sloping? Briefly, why or why not?
(b) Put country A’s offer curve together with the offer curve of a trading partner country
(call it country B) and indicate the equilibrium position. Then suppose that, from this
equilibrium position, country A’s consumers now change their tastes toward wanting
relatively more of A’s export good at the same time that country B reduces its tariff on
A’s export good. Explain the impact of each event separately on the volume of trade of
each good and on the terms of trade. Then indicate whether it is possible to assess, when
the new equilibrium position is attained, the net results of the two shifts together on the
volume of trade of each good and on the terms of trade (in comparison with the initial
equilibrium). (Assume that the offer curves are “elastic” throughout.)
B. Multiple-Choice Questions
10. The “income terms of trade” index would be calculated by which one of the following
formulas (where PX = price index of exports, PM = price index of imports, QX = quantity
index of exports, and QM = quantity index of imports)?
a. (PX/PM)⋅100
b. (QM/QX)⋅100
* c. (PX⋅QX)/PM
d. (PX⋅QX)/(PM⋅QM )⋅100
11. In deriving an offer curve for a country, if a higher price of exports/price of imports leads
to a reduction in the quantity of exports which the country is willing to supply, then, in
this range of the offer curve, the offer curve is said to be __________.
* a. inelastic
b. unit-elastic
c. elastic
d. inelastic, unit-elastic, or elastic – cannot be determined without more information
12. If country I is trading in the inelastic range of country II’s offer curve, then the imposition
of a tariff by country I, which still leaves country I in the inelastic range of country II’s
curve, will (assuming no retaliation) lead to __________ in country I’s terms of trade and
to __________ in the volume of imports of country I.
a. a deterioration; a decrease
b. a deterioration; an increase
c. an improvement; a decrease
* d. an improvement; an increase
70
13. In the following partially-completed table showing country I’s demand for import good Y
and supply of export good X at various terms of trade,
TOT Y demanded X supplied
4Y:1X 400Y 100X

3Y:1X v 120X
2Y:1X 300Y w
a. v = 40Y; w = 600X
* b. v = 360Y; w = 150X
c. v = 350Y; w = 140X
d. v = 360Y; w = 140X
14. In an offer curve graph with country A’s exports on the horizontal axis and country B’s
exports on the vertical axis, which one of the following events will shift or pivot country
A’s offer curve to the right?
a. the imposition of a tariff by country B

b. a decrease in demand by A for B’s products
* c. a tariff reduction by A on B’s products
d. an increase in demand by B for A’s products
15. Suppose that country I is importing good Y and exporting good X. At a terms of trade of
1X:4Y, country I is willing to import 60 units of Y and to export 15 units of X in
exchange; at a terms of trade of 1X:5Y, country I is willing to import 70 units of Y and to
export 14 units of X in exchange. Considering just these two offer curve points, country
I’s demand for imports between the two points is __________.
a. elastic
b. unit-elastic
* c. inelastic
d. elastic, unit-elastic, or inelastic – cannot be determined without more information
16. In an offer curve graph with country A’s exports on the horizontal axis and country B’s
exports on the vertical axis, which one of the following events will shift or pivot country
B’s offer curve downward (or to the right)?
a. decreased demand by A for B-goods

71
b. technological improvement in B’s industries
c. imposition of a tariff by A
* d. imposition of a tariff by B
17. International Monetary Fund data indicate that, with 2010 = 100.0, Thailand’s unit-value
index of exports (average price) for 2014 was 107.6 and Thailand’s unit-value index of
imports (average price) for 2014 was 104.8. Further, with 2010 = 100.0, the United
Kingdom’s unit-value index of exports for 2014 was 109.7 and the United Kingdom’s
unit-value index of imports for 2014 was 110.3. With this information, an economist
would say that, from 2010 to 2014, Thailand experienced __________ in its commodity
terms of trade and the United Kingdom __________ in its commodity terms of trade.
a. a deterioration; also experienced a deterioration

b. a deterioration; experienced an improvement
* c. an improvement; experienced a deterioration
d. an improvement; also experienced an improvement
18. In the following offer curve diagram,
at TOT1, there is excess demand for __________, and the movement to equilibrium will
result in better terms of trade for __________.
* a. wine; France
b. wine; Korea
c. clothing; France
d. clothing; Korea
19. In the graph in Question #18 above, suppose that, when trade is taking place at the
equilibrium position, consumers in France now change tastes and shift their demand more
toward clothing and away from wine. This change in tastes would
* a. cause France’s offer curve to shift or pivot downward and to the right.
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b. cause France’s offer curve to shift or pivot upward and to the left.
c. cause Korea’s offer curve to shift or pivot upward and to the left.
d. cause Korea’s offer curve to shift or pivot downward and to the right.
20. Suppose that a country is exporting good X and importing good Y. Suppose also that, in
a particular range of the country’s offer curve, a rise in the relative price of X causes the
country to export less of X and to import more of Y. Then, in this range,
a. with respect to good Y, the “income effect” of a rise in the terms of trade outweighs
the “substitution effect” and the “production effect.”
b. with respect to good X, the “substitution effect” of a rise in the terms of trade
outweighs the “income effect” and the “production effect.”
c. with respect to good X, the “production effect” of a rise in the terms of trade
outweighs the “substitution effect” and the “income effect.”
* d. with respect to good X, the “income effect” of a rise in the terms of trade outweighs
the “substitution effect” and the “production effect.”
21. In the following offer curve diagram,
if, starting from the initial equilibrium point E, countries A and B both increase their
demand for computers, then country A’s terms of trade will __________ and the volume
of A’s exports will __________.
a. improve; fall
* b. improve; rise, fall, or stay the same (cannot be determined without more
information)
c. deteriorate; rise
d. improve, deteriorate, or stay the same (cannot be determined without more
information); rise
22. A “small” country in international trade is defined as
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a. a country that can influence its volume of trade.
b. a country that can influence its terms of trade.
c. a country that cannot influence its volume of trade.
* d. a country that cannot influence its terms of trade.
23. In an offer curve diagram with country A’s export good (country B’s import good) on the
horizontal axis and country B’s export good (country A’s import good) on the vertical
axis, which one of the following events will shift or pivot country B’s offer curve upward
(or to the left)?
a. increased demand by A for B’s export good

b. technological improvement in A’s export industry
c. imposition of a tariff by B
* d. a change in tastes by B’s consumers toward wanting more of A’s export good
and less of B’s export good
exchange; at a terms of trade of 1X:5Y, country I is willing to import 75 units of Y and to
export 15 units of X in exchange. Considering just these two offer curve points, country
I’s demand for imports between the two points is __________.
a. elastic
* b. unit-elastic
c. inelastic
d. elastic, unit-elastic, or inelastic – cannot be determined without more information
25. In the following offer curve diagram, showing one normally-shaped offer curve and one
straight-line offer curve,
74
Germany is exporting good __________, and __________ is a “small country” in this
particular situation.
a. X; France
b. X; Germany
c. Y; France
* d. Y; Germany
26. In a two-commodity, two-country trading world (as in the offer curve diagrams), if, at a
given terms of trade (price of good X ÷ price of good Y), there is an excess demand for
good X, then there must __________ and the price of good X relative to the price of good
Y will therefore __________.
a. also be an excess demand for good Y; rise

b. also be an excess demand for good Y; rise, fall, or not change – cannot be determined
without more information
* c. be an excess supply of good Y; rise
d. be an excess supply of good Y; fall
27. International Monetary Fund data indicate that, with 2005 = 100.0, Sweden’s export price
index in 2011 was 129.7, its import price index in 2011 was 133.3, its export quantity
index in 2011 was 115.9, and its import quantity index in 2011 was 129.0. Given this
information, a calculation of Sweden’s “income” terms of trade for 2011 would give a
result of __________.
a. 87.4
* b. 112.8
c. 119.1
d. 132.6
exchange; at a terms of trade of 1X:4Y, country I is willing to import 128 units of Y and
to export 32 units of X in exchange. Considering just these two offer curve points,
country I’s demand for imports over the range between these two points is __________.
a. inelastic
b. unit elastic
* c. elastic
d. inelastic, unit elastic, or elastic – cannot be determined without more
information
75

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International Economics 9th Edition

Appleyard Solutions Manual

■ Describe a country’s offer curve and show how it is obtained.

II. Special Chapter Features

Concept Box 1: The Tabular Approach to Deriving an Offer Curve

III. Purpose of Chapter

V. Answers to End-of-Chapter Questions and Problems

9. “Behaving rationally” occurs even with a “backward-bending” offer curve. The

VI. Sample Exam Questions

1. Suppose that a home country is contemplating the imposition of a tariff in order to

possible terms I’s quantity demanded

(a) 1X:1Y or PX/PY = 1 20 units

(b) 1X:2Y or PX/PY = 2 46 units

(c) 1X:3Y or PX/PY = 3 69 units

(d) 1X:4Y or PX/PY = 4 84 units

price of exports = 108 quantity of exports = 116

TOT Y demanded X supplied

4Y:1X 400Y 100X

a. the imposition of a tariff by country B

a. decreased demand by A for B-goods

a. a deterioration; also experienced a deterioration

18. In the following offer curve diagram,

21. In the following offer curve diagram,

22. A “small” country in international trade is defined as

a. increased demand by A for B’s export good

a. also be an excess demand for good Y; rise

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