Mankiw 5e Chapter 1: The Science of Macroeconomics

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International Trade Theory Chapter 4. Demand and
Supply, Offer Curves and the Terms of Trade

• Hyun-Hoon Lee

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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

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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

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

• Figure 4.1. The Equilibrium-Relative Commodity
  Price with Trade Partial Equilibrium Analysis

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4.3 Offer Curves

• 4.3A. Origin and Definition of Offer Curves
• (Reciprocal Demand Curves)
• Introduced by Marshall and Edgeworth
• Definition

The offer curve of a nation shows the nations
willingness to import and export at various
relative commodity prices.
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4.3 Offer Curves

• 4.3B. Derivation and Shape of the Offer Curve of
  Nation 1

Figure 4.3. Derivation of the Offer Curve of
Nation 1
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4.3 Offer Curves

• 4.3C. Derivation and Shape of the Offer Curve of
  Nation 2

Figure 4.4. Derivation of the Offer Curve of
Nation 2
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4.4 The Equilibrium-Relative Commodity Price with
Trade-General Equilibrium Analysis
Figure 4.5. Equilibrium-Relative Commodity Price
with Trade
4.5 Skip
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4.6 The Terms of Trade
4.6A. Definition and Measurement of the Terms of
Trade

• Definition The terms of trade of a nation are
  defined as the ratio of the price of its export
  commodity to the price of its import commodity.
• i.e., The TOT of Nation 1 Px/Py
• The TOT of Nation 2 Py/Px
• If Px/Py increases, the TOT of Nation 1 improve
  and the TOT of Nation 2 deteriorate.
• In a world of many trade commodities, the terms
  of trade of a nation are given by the ratio of
  the price index of its exports of the price index
  of its imports.

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4.6 The Terms of Trade
4.6B. Illustration of the Terms of Trade

• Case Study 4-2 The Index of Export to Import
  Prices for the United States

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

• Case Study 4-3 The Terms of Trade of the G-7
  Countries

Source Elaborated from data IMF, International
Financial Statistics (Washington, D.C., 2006)
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4.6 The Terms of Trade
4.6B. Illustration of the Terms of Trade

• Case Study 4-4 The Terms of Trade of Industrial
  and Developing Countries
  
  (1995100)

Source Elaborated from data IMF, International
Financial Statistics (Washington, D.C., 2002)
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4.6 The Terms of Trade
4.6C. Usefulness of the Model

• In Chapters 3 and 4, our standard trade model
  showed
• - the conditions of production and demand
  preferences in the two nations,
• - the autarky point of production and
  consumption,
• - the equilibrium-relative commodity price in
  the absence of trade,
• - the comparative advantage of each nation,

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4.6 The Terms of Trade
4.6C. Usefulness of the Model

• Our standard trade model showed (continued)
• - the degree of specialization in production
  with trade,
• - the volume of trade,
• - the terms of trade,
• - the gains from trade,
• - and the shares of these gains going to each of
  the trading nations.

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4.6 The Terms of Trade
4.6C. Usefulness of the Model

• Our model is useful in that we can use the model
  to examine how a change in demand and/or supply
  conditions in a nation would affect (? Chapter
  7)
• - the terms of trade,
• - the volume of trade,
• - the gains from trade,
• - and the shares of these gains going to each of
  the trading nations.

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4.6 The Terms of Trade
4.6C. Usefulness of the Model

• Extension of the model in Chapter 5
• To identify the basis for comparative advantage.
  (i.e., What determines comparative advantage?)
• To examine the effect of international trade on
  the earning of factors of production in the two
  trading nations.