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International Economics

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  1. International Economics Li Yumei Economics & Management School of Southwest University

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

  3. Organization • 4.1 Introduction • 4.2 The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis • 4.3 Offer Curves • 4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis • 4.5 Relationship between General and Partial Equilibrium Analysis • 4.6 The Terms of Trade • Chapter Summary • Exercises

  4. 4.1 Introduction • To Develop the Simple Trade Model Completely • How to determine the equilibrium-relative commodity price and terms of trade of each nation precisely • Partial Equilibrium Analysis (utilizing demand and supply curves) • General Equilibrium Analysis (Offer Curves) • How to determine the gains from trade are shared by each nation • Trade Terms

  5. 4.2 The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis • How the Equilibrium-relative commodity price with trade is determined with demand and supply curves ( with partial equilibrium analysis) See Figure 4.1 The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium Analysis

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

  7. 4.2 The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis • Explanation of Figure 4.1 • Curves DX and SX in panels A and C of Figure 4.1 refer to the demand and supply curves for commodity X of Nation 1 and Nation 2 respectively. The vertical axes in all three panels measure the relative price of commodity X. The horizontal axes measure the quantities of commodity X. • Figure 4.1 shows that in the absence of trade, Nation 1 produces and consumes at point A at the relative price of X of P1, while Nation 2 produces and consumes at point A’ at P3. • With the opening of trade, the relative price of X will be between P1 and P3 if both nations are large. If the price is above P1, Nation 1 has excess supply while Nation 2 has excess demand when the price is below P3. Until at P2 the quantity of imports of commodity X demanded by Nation 2 equals the quantity of exports of commodity X supplied by Nation 1.

  8. 4.2 The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis • Partial Equilibrium Analysis The excess supply of a commodity above the no-trade equilibrium price gives one nation’s export supply of a commodity. On the other hand, the excess demand of a commodity below the no-trade equilibrium price gives the other nation’s import demand for the commodity. The intersection of the demand curve for imports and the supply curve for exports of the commodity defines the partial equilibrium-relative price and quantity of the commodity at which trade takes place. • Case Study 4-1 and 4-2 page from 92 to 93

  9. 4.3 Offer Curves • Origin and Definition of Offer Curves • Derivation and Shape of the Offer Curve of Nation 1 • Derivation and Shape of the Offer Curve of Nation 2 • Conclusion

  10. Origin and Definition of Offer Curves In this section , first how to derive the offer curves of the two nations and then examine the reasons for their shape. • Origin of Offer Curves Offer curves were devised and introduced into international economics by 1. Alfred Marshall (1842-1924) 2. Francis Ysidro Edgeworth (1845-1926)

  11. Alfred Marshall (1842-1924) Alfred Marshall was the dominant figure in British economics (itself dominant in world economics) from about 1890 until his death in 1924. His specialty was microeconomics—the study of individual markets and industries, as opposed to the study of the whole economy. His most important book was Principles of Economics. In it Marshall emphasized that the price and

  12. Alfred Marshall (1842-1924) output of a good are determined by both supply and demand: the two curves are like scissor blades that intersect at equilibrium. Modern economists trying to understand why the price of a good changes still start by looking for factors that may have shifted demand or supply. They owe this approach to Marshall; To Marshall also goes credit for the concept of price-elasticity of demand, which quantifies buyers' sensitivity to price; Marshall also originated the concept of consumer surplus ; Marshall himself was born into a middle-class family in London and raised to enter the clergy(教士). He defied his parents' wishes and became an academic in mathematics and economics.

  13. Francis Ysidro Edgeworth (1845-1926) Edgeworth was born in 1845 in Edgeworthstown, County Longford, Ireland into a large, Edgeworth was educated at Edgeworthstown by tutors until 1862, then he went on to study languages and the classics at Trinity College, Dublin.  He proceeded in 1867 to Oxford . it was in this 1881 book that Edgeworth introduced into economics the generalized utility function, U(x, y, z, ...), and drew the first "indifference curve". 

  14. Francis Ysidro Edgeworth (1845-1926) In 1894, he published a survey of international trade theory in a series of articles in the Economic Journal.   In it, he pioneered the use of offer curves and community indifference curves to illustrate its main propositions, including the "optimum tariff".; In 1897, he published a lengthy survey of taxation.   It was here that he articulated his famous "taxation paradox", i.e. that taxation of a good may actually result in a decrease in price. (See detailed introduction about Francis Ysidro Edgeworth)

  15. Origin and Definition of Offer Curves • Offer curves (or Reciprocal demand curves) The offer curve of a nation shows how much of its import commodity the nation demands for it to be willing to supply various amounts of its export commodity. Offer curves incorporate elements of both demand and supply. In other words, the offer curve of a nation shows the nation’s willingness to import and export at various relative commodity prices. The offer curve of a nation can be derived from the nation’s production frontier and indifference curve, the various hypothetical relative commodity prices at which trade could take place

  16. Derivation and Shape of the Offer Curve of Nation 1 • Figure 4.3 Derivation of the Offer Curve of Nation1 FIGURE 4-3 Derivation of the Offer Curve of Nation 1.

  17. Derivation and Shape of the Offer Curve of Nation 1 • Explanation of Figure 4.3 1.At point A no trade ( or autarky), PA=PX/PY=1/4; 2. If trade takes at point F, PF=PX/PY=1/2; Nation 1 would exchange 40X for 20Y with Nation 2 and reach point H on its indifference curve Ⅱ; 3. If trade takes at Point B, PB=PX/PY=1; Nation 1 would exchange 60X for 60 Y with Nation 2 and reach point E on its indifference curve Ⅲ; 4. Offer curve of Nation 1, left panel At different relative prices of commodity X, connecting the different combination of exported commodity X and imported commodity Y respectively.

  18. Derivation and Shape of the Offer Curve of Nation 1 • Explanation of Nation 1’s Offer Curve Shape Nation 1’s offer curve lies above the autarky price (1/4) and bulges (凸出) towards the X-axis , which means the commodity of its comparative advantage and export. ( Nation 1 export more of commodity X, PX/PY must rise). Why Nation 1 exports more of commodity X with the increase of PX/PY)? 1. Nation 1 incurs increasing opportunity costs in producing more of commodity X (for export); 2. The more of commodity Y and the less of commodity X that Nation 1 consumes with trade, the more valuable to the nation is a unit of X at the margin compared with a unit of Y.

  19. Derivation and Shape of the Offer Curve of Nation 2 • Figure 4.4 Derivation of the Offer Curve of Nation 2 FIGURE 4-4 Derivation of the Offer Curve of Nation 2

  20. Derivation and Shape of the Offer Curve of Nation 2 • Explanation of Figure 4.4 1.At point A’ no trade ( or autarky), PA=PX/PY=4; 2. If trade takes at point F’, PF=PX/PY=2; Nation 1 would exchange 40Y for 20X with Nation 1 and reach point H’ on its indifference curve Ⅱ; 3. If trade takes at Point B’, PB’=PX/PY=1; Nation 2 would exchange 60Y for 60 X with Nation 1 and reach point E’ on its indifference curve Ⅲ; 4. Offer curve of Nation 2, left panel At different relative prices of commodity X, connecting the different combination of exported commodity Y and imported commodity X respectively.

  21. Derivation and Shape of the Offer Curve of Nation 1 • Explanation of Nation 2’s Offer Curve Shape Nation 1’s offer curve lies below the autarky price (4) and bulges (凸出) towards the Y-axis , which means the commodity of its comparative advantage and export. ( Nation 2 export more of commodity Y, PY/PX must rise). Why Nation 1 exports more of commodity X with the increase of PX/PY)? 1. Nation 1 incurs increasing opportunity costs in producing more of commodity Y (for export); 2. The more of commodity X and the less of commodity Y that Nation 2 consumes with trade, the more valuable to the nation is a unit of Y at the margin compared with a unit of X.

  22. Conclusion The offer curve of a nation shows how much of its import commodity the nation demands to be willing to supply various amounts of its export commodity. The offer curve of a nation can be derived from its production frontier, its indifference map, and the various relative commodity prices at which trade could take place. The offer curve of each nation bends toward the axis measuring the commodity of its comparative advantage. The offer curves of two nations will lie between their pre-trade, or autarky, relative commodity prices. To induce a nation to export more of a commodity, the relative price of the commodity must rise.

  23. 4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis • Figure 4.5 (Page 97) FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade

  24. 4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis • Figure 4.5 (Page 97) FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade

  25. 4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis • Explanation of Figure 4.5 (Page 97) 1. Trade is in equilibrium at PB. PX/PY=PB=PB’=1, Nation 1 offers 60X for 60Y (point E on Nation 1’s offer curve), and Nation 2 offers 60Y for 60X (point E’ on Nation 2’s offer curve), both nations happen to gain equally from trade. 2. At any other PX/PY, trade would not be in equilibrium. • At any PX/PY﹤1, the quantity of exports of commodity X supplied by Nation 1 would fall short of the quantity of imports of commodity X demanded. This would drive the relative commodity price up to the equilibrium level. • The opposite would be true at PX/PY﹥1

  26. 4.4 The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis • Conclusion The intersection of the offer curves of two nations defines the equilibrium-relative commodity price at which trade takes place between them. Only at this equilibrium price will trade be balanced. At any other relative commodity price, the desired quantities of imports and exports of the two commodities would not be equal. This would put pressure on the relative commodity price to move toward its equilibrium level.

  27. 4.5 Relationship between General and Partial Equilibrium Analysis • Figure 4.6 (page 98) FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis

  28. 4.5 Relationship between General and Partial Equilibrium Analysis • Explanation of Figure 4.6 (page 98) 1. S refers to Nation 1’s supply curve of exports of commodity X; D refers to Nation 2’s demand curve for Nation 1’s exports of commodity X; 2. D and S intersect at point E determine the equilibrium point; 3. It shows that PX/PY﹥1 there is an excess supply of exports of commodity X; PX/PY ﹤1 there is an excess demand of commodity X.

  29. 4.6 The Terms of Trade • Definition and Measurement of the Terms of Trade • Illustration of the Terms of Trade • Usefulness of the Model

  30. 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. As for a two-nation world, the exports of a nation are the imports of its trade partner, the terms of trade of the later are equal to the inverse, or reciprocal , of the terms of trade of the former.

  31. Definition and Measurement of the Terms of Trade • Measurement In a world of many traded commodities, the terms of trade of a nation are given by the ratio of the price index of its exports to the price index of its imports. This ratio is usually multiplied by 100 in order to express the terms of trade in percentage. These terms of trade are often referred to as the commodity or net barter terms of trade to distinguish them from other measures of the terms of trade presented in Chapter 11 in connection with trade and development.

  32. Definition and Measurement of the Terms of Trade 1. Trade improvement An improvement in a nation’s terms of trade is usually regarded as beneficial to the nation in the sense that the prices that the nation receives for its exports rise relative to the prices that it pays for imports. 2. Trade deterioration An deterioration in a nation’s terms of trade is usually regarded as harmful to the nation in the sense that the prices that the nation receives for its exports decrease relative to the prices that it pays for imports.

  33. Illustration of the Terms of Trade • Nation 1 exports commodity X and imports commodity Y, the terms of trade of Nation 1 are given by PX/PY (When PX/PY=1means 100 percentages) • Nation 2 exports commodity Y and imports commodity X, the terms of trade of Nation 2 are given by PY/PX • One Nation’s terms of trade improves means its trading partner’s terms of trade deteriorates. (e.g. the middle page 100) Case study 4-3 and 4-4 from page 101 to 102

  34. Usefulness of the Model • General Equilibrium Model It shows the conditions of production, supply, in the two nations, the tastes, or demand preferences, the autarky point of production and consumption, the equilibrium-relative commodity price in the absence of trade, and the comparative advantage of each nation; It also shows the degree of specialization in production with trade, the volume of trade, the terms of trade, the gains from trade, and the share of these gains going to each of the trading nations. • The Further Extension of the Trade Model To identify the basis for comparative advantage; To examine the effect of international trade on the returns, or earnings, of resources or factors of production in the two trading nations.

  35. Chapter Summary • In this chapter by using the offer curve of a nation the trade equilibrium point can be clearly and precisely determined. • To further the trade model as a completely general equilibrium model. It can be used to examine how a change in demand and or supply conditions in a nation would affect the terms of trade, the volume of trade, and the share of the gains from trade in each nation ( this is done in chapter 7) • Limitations: to identify the basis for comparative advantages; to examine the returns or earnings of resources or factors of production

  36. Exercises Discussion Questions: Page 105 from 1 to 13 questions

  37. Exercises Additional Reading An excellent discussion of offer curves is found in: • A.P.Lerner, “The Diagrammatic Representation of Demand Conditions in International Trade,” Economica, 1934, pp.319-334 • G. Haberler, The Theory of International Trade (London:W. Hodge & Co., 1936), ch.11 For the law of reciprocal demand, see: • J.S.Mill, Principle of Political Economy (New York: Kelly, 1965, a reprint of Mill’s 1848 treatise ) , ch.18

  38. Internet Materials • http://www.imf.org • http://www.eia.doe.gov