Demand and Supply, Offer Curves and Terms of Trade Chapter 4

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Demand and Supply, Offer Curves and Terms of
Trade Chapter 4
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1 Introduction

• Derive the demand and supply curve, derive offer
  curves for the two nations, and determine the
  equilibrium volume of trade and the equilibrium
  relative commodity price
• Make partial equilibrium analysis to derive the
  relative commodity price with trade
• Make general equilibrium analysis to derive the
  offer curves
• Analyze the interaction of the offer curves of
  the two nations
• Discuss the terms of trade.

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1 Introduction

• Offer curves
• Terms of demand
• Commodity or net barter terms of trade
• General equilibrium model

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2 Partial Equilibrium Analysis

• Partial equilibrium analysis utilizes the demand
  and supply curves to derive the equilibrium
  relative commodity prices.
• It deals with the market for one commodity,
  either X or Y. It does not consider the mutual
  influence of the two commodities.

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2 Partial Equilibrium Analysis
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3 Offer Curves
An offer curve of a nation shows how much
the nation is willing to export and how much the
nation is willing to import at various relative
commodity prices. The offer curve can be
derived rather easily from the nation's
production frontier, its indifference map, and
the various relative commodity prices at which
trade takes place.
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3.1 Derivation of Offer Curves of Nation 1
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3.2 Derivation of Offer Curves of Nation 2
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4 General Equilibrium Analysis
The intersection of the two curves defines
the equilibrium relative commodity price at which
trade takes place between them. Only at
this equilibrium prices will trade be balanced
between the two nations. 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.
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4 General Equilibrium Analysis
Equilibrium Relative Commodity Price with Trade
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5 Equilibrium Relative Commodity Price with
Partial Equilibrium Analyses
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5.1 Comparison between Partial General
Equilibrium Analysis
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5.1 Comparison between Partial General
Equilibrium Analysis
Both analyses are derived from the nation's
production frontiers and indifference maps, and
they show the same information. But in
general equilibrium analysis, we consider all
markets together, not just the market for
commodity X. This is very important because
changes in the market for commodity X affect
other markets and these may give rise to
important influence on the market for commodity X
itself. On the other hand, the partial
equilibrium analysis only uses demand and supply
curves. It does not consider the influence and
the connections that exist between the market for
commodity X and the market for all other
commodities in the economy.
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5.2 Usefulness of the General Equilibrium Model
General equilibrium model shows the
conditions of production in the two nations, the
tastes or demand preference, the autarky point of
production and equilibrium 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.
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6 Terms of Trade
They are the ratio of the price index of its
exports (Px) to the price index of its imports
(PM ). This ratio is usually multiplied by 100 in
order to express the terms of trade in
percentage. An improvement in a nation's
terms of trade is usually regarded as beneficial
to the nation in the sense that the prices the
nation receives for its exports rise relative to
the prices it pays for imports. Commodity
or net barter, terms of trade (N) N
(PX /PM )100 N (PX /PM ) 100(100/120
)10083
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7 Questions for Discussion

• What do offer curves show? How are they derived?
  What is their shape? What explains their shape?
• What are the forces that push any
  non-equilibrium-relative commodity price toward
  the equilibrium level?
• How is the equilibrium relative commodity price
  with trade determined with demand and supply
  curves?

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Thank You