Transcript Chapter 2
Chapter 2
How is TOT established
Mill’s Reciprocal Demand Principle
Graph
Autarky
Trade equilibrium
Offer Curve
Conception
How to derive offer curve
Trade equilibrium
Chapter 2
Autarky
Price Line
Y
A
K
Y0
I2
I0
O
X0 B
X
I1
Chapter 2
Trade Equilibrium
Chapter 2
Offer Curves are
all combinations of a country’s desired
exports and imports at different terms
of trade
also known as reciprocal demand curves
(J.S. Mills)
measures of willingness to trade
Chapter 2
Y
Y1
Y2
Y
C
P
(PX/PY)1
X1
X2
X
(PX/PY)1
Y5
X5
X
Chapter 2
Y
Y3
(PX/PY)1
Y4
(PX/PY)2
Y
X3
X4
X
(PX/PY)2
(PX/PY)1
Y6
Y5
X5 X6
X
Chapter 2
Y
Y3
(PX/PY)1
Y4
(PX/PY)2
Y
X3
OCA
X4
X
(PX/PY)2
(PX/PY)1
Y6
Y5
X5 X6
X
Chapter 2
Offer Curves
Offer curves represent willingness to
trade at every possible terms of trade
As the relative price of good X rises,
Country A becomes willing to export
more and import more
Offer curves “bow” towards the import
good axis
Chapter 2
Deriving Country B’s Offer
Curve
This will reflect Country B’s willingness
to trade at different terms of trade
B’s offer curve bows towards the axis
with B’s import good on it
Chapter 2
Y
(PX/PY)1
p
Y7
c
Y8
Y
X7
X8
X
(PX/PY)1
Y9
X9
X
Chapter 2
Y
(PX/PY)1
Y10
(PX/PY)2
Y11
Y
X10
X11 X
(PX/PY)1
(PX/PY)2
OCB
Y12
Y9
X9
X12
X
Chapter 2
Terms of Trade Equilibrium
The international terms of trade (that is,
PX/PY) will be the slope of a line passing
through the point where the offer
curves cross.
This equilibrium point takes into
account demand and supply conditions
in both countries
Chapter 2
Terms of Trade Equilibrium
Y
OCA
(PX/PY)E
OCB
If these are the terms of trade,
country A will desire to export
X1 units, and country B will
want to import X1 units;
Y1
X1
country A will desire to import
Y1 units, and country B will
want to export Y1 units
X
Chapter 2
How Do We Know It’s
Equilibrium?
Any terms of trade other than (PX/PY)E
will result in
excess demand for one good
excess supply for the other
Therefore relative prices will adjust until
(PX/PY)E is reached
Chapter 2
Disequilibrium
Y
OCA
(PX/PY)1
Y1
Y2
OCB
At (PX/PY)1, country A wishes
to import Y1 units, but country B
is only interested in exporting Y2
units. That is, there is an excess
demand for good Y.
X
Chapter 2
Disequilibrium
OCA
Y
(PX/PY)1
OCB
At (PX/PY)1, country A wishes
to export X1 units, but country B
is only interested in importing X2
units. That is, there is an excess
supply of good X.
X2
X1
X
Chapter 2
Disequilibrium
Excess demand for Y causes PY to rise
Excess supply of X causes PX to fall
Thus, (PX/PY) falls
In other words, the terms of trade line
gets flatter, moving the countries in the
direction of equilibrium
Chapter 2
Moving Towards Equilibrium
Y
(PX/PY)1
OCA
OCB
X
Chapter 2
Disequilibrium
Terms of trade lines that are flatter than
(PX/PY)E, such as
Y
OCA
(PX/PY)2
OCB
X
Chapter 2
Disequilibrium
Terms of trade lines that are flatter than
(PX/PY)E will results in
an excess demand for good X
an excess supply of good Y, and so
(PX/PY) will rise
That is, the terms of trade line will get
steeper until (PX/PY)E is reached
Chapter 2
Moving Towards Equilibrium
Y
(PX/PY)2
OCA
OCB
X