international economics international economics tenth edition demand and supply, offer curves, and...

International International EconomicsEconomics

Tenth Edition

Demand and Supply, Offer Curves, and the Terms of Trade

Dominick SalvatoreJohn Wiley & Sons, Inc.

Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

CHAPTER F O U R

44

4.1 Introduction

Chapter 3 showed: a difference in relative commodity prices between two

nations in isolation is a reflection of their comparative advantage and

with trade, the equilibrium-relative commodity price is determined somewhere between the autarkic relative prices.

Chapter 4 presents a more rigorous theoretical way of determining the equilibrium-relative commodity price with trade. 4.2 Partial Equilibrium Analysis (Skip) 4.3-4.4 General Equilibrium Analysis

OUTLINE

4.1 Introduction

4.2 The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis (Skip)

4.3 Offer Curves

4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis

4.5 Relationship between General and Partial Equilibrium Analyses (Skip)

4.6 The Terms of Trade

4.2. The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis

See Figure 4-1 (next slide):

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.


FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium Analysis.


FIGURE 4-2 Index of Relative U.S. Export Prices (1995 = 100).


4.3. Offer Curves

Offer curves (sometimes called reciprocal demand curves) introduced to international economics by Marshall and Edgeworth.

Shows 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.


4.3. Offer Curves

FIGURE 4-4 Derivation of the Offer Curve of Nation 2.


4.4. The Equilibrium-Relative Commodity Price 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.


4.5. Relationship between General and Partial Equilibrium Analyses (Skip) 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.


4.6. 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.


4.6A. Definition and Measurement of the Terms of Trade

FIGURE 4-2 Index of Relative U.S. Export Prices (1995 = 100).


4.6 The Terms of Trade

4.6B. Illustration of the Terms of TradeCase Study 4-2 (supplement) Net Barter Terms of Trade Index for Korea

international economics international economics tenth edition demand and supply, offer curves, and...

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