Offer%20Curves

1
Offer Curves

• How the Terms of Trade Are Established

2
Offer Curves are

• all combinations of a countrys desired exports
  and imports at different terms of trade
• also known as reciprocal demand curves (J.S.
  Mills)
• measures of willingness to trade

3
Y
C
P
Y1
Y2
(PX/PY)1
X
Y
X2
X1
X
4
Y
C
P
Y1
Y2
(PX/PY)1
X
Y
X2
X1
(PX/PY)1
Y5
X
X5
5
Y
Y3
(PX/PY)1
Y4
(PX/PY)2
X4
X3
X
Y
(PX/PY)2
(PX/PY)1
Y6
Y5
X
X5
X6
6
Y
Y3
(PX/PY)1
Y4
(PX/PY)2
X4
X3
X
Y
(PX/PY)2
OCA
(PX/PY)1
Y6
Y5
X
X5
X6
7
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

8
Deriving Country Bs Offer Curve

• This will reflect Country Bs willingness to
  trade at different terms of trade
• Bs offer curve bows towards the axis with Bs
  import good on it

9
Y
(PX/PY)1
p
Y7
c
Y8
X
Y
X7
X8
X
10
Y
(PX/PY)1
p
Y7
c
Y8
X
Y
X7
X8
(PX/PY)1
Y9
X
X9
11
Y
(PX/PY)1
Y10
(PX/PY)2
Y11
X
Y
X10
X11
(PX/PY)1
(PX/PY)2
OCB
Y12
Y9
X
X9
X12
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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

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Terms of Trade Equilibrium
OCA
(PX/PY)E
Y
OCB
Y1
X1
X
14
Terms of Trade Equilibrium
OCA
(PX/PY)E
Y
OCB
Y1
If these are the terms of trade, country A will
desire to export X1 units, and country B will
want to import X1 units
X1
X
15
Terms of Trade Equilibrium
OCA
(PX/PY)E
Y
OCB
Y1
If these are the terms of trade, country A will
desire to import Y1 units, and country B will
want to export Y1 units
X1
X
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How Do We Know Its 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

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Disequilibrium
OCA
(PX/PY)1
Y
OCB
X
18
Disequilibrium
OCA
(PX/PY)1
Y
Y1
OCB
Y2
X
19
Disequilibrium
OCA
(PX/PY)1
Y
Y1
OCB
Y2
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
20
Disequilibrium
OCA
(PX/PY)1
Y
OCB
X2
X1
X
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Disequilibrium
OCA
(PX/PY)1
Y
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
22
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

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Moving Towards Equilibrium
OCA
(PX/PY)1
Y
OCB
X
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Disequilibrium

• Terms of trade lines that are flatter than
  (PX/PY)E, such as

25
Disequilibrium
OCA
(PX/PY)2
Y
OCB
X
26
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

27
Moving Towards Equilibrium
OCA
(PX/PY)2
Y
OCB
X
28
A Note on the Terms of Trade

• A countrys terms of trade are the price of its
  exports divided by the price of its imports, so a
  rising terms of trade is good news
• In this example, (PX/PY) is country As terms of
  trade, since A exports good X and imports Y
• (PY/PX) is country Bs terms of trade in this
  example

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A Note on the Terms of Trade, continued

• As As terms of trade (PX/PY) improve, Bs terms
  of trade (PY/PX) must be deteriorating and
  vice-versa

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Shifts of Offer Curves

• Anything that causes country As willingness to
  trade to change will shift As offer curve
• increased willingness to trade OCA shifts right
• decreased willingness to trade OCA shifts left
• These can be caused by
• changes in demand conditions or
• changes in supply conditions

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Demand Changes in Country A
OCA
(PX/PY)E
Y
OCB
Y1
X1
X
32
Demand Changes in Country A
OCA'
OCA
(PX/PY)E
Y
OCB
Increased demand for imports by Country A causes
a rightward shift of As offer curve
X
33
Demand Changes in Country A
OCA'
OCA
(PX/PY)E
Y
(PX/PY)E'
OCB
Y2
Volume of trade increases, but As terms of trade
go down. Bs terms of trade improve.
X2
X
34
Demand Changes in A

• Any change that might make A demand more imports
  leads to a rightward OC shift, and thus
• an increase in trade volume
• a decrease in As terms of trade

35
Demand Changes in Country B
OCA
(PX/PY)E
Y
OCB
Y1
X1
X
36
Demand Changes in Country B
OCA
(PX/PY)E
Y
OCB'
OCB
Increased demand for imports by Country B shifts
Bs OC upward
X
37
Demand Changes in Country B
OCA
(PX/PY)E
Y
(PX/PY)E'
OCB'
OCB
Y2
Volume of trade increases, but Country Bs terms
of trade decrease (and As terms of trade
improve).
X2
X
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Other Demand Changes

• Any decrease in a countrys willingness to trade
  will shift its OC leftward or downward
• An example is when a country imposes an import
  tariff
• Tariffs therefore lead to decreased trade volume,
  but improve the imposing countrys terms of trade

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Imposition of Tariff by Country A
OCA
(PX/PY)E
Y
OCB
Y1
X1
X
40
Imposition of Tariff by Country A
OCA
OCA'
(PX/PY)E
Y
OCB
Y1
X1
X
41
Imposition of Tariff by Country A
(PX/PY)E'
OCA
OCA'
Y
(PX/PY)E
OCB
Y2
X2
X
42
Imposition of Tariff by Country A
(PX/PY)E'
OCA
OCA'
Y
(PX/PY)E
OCB
Y2
By imposing a tariff, Country A decreases trade
volume, and improves its terms of trade (but Bs
terms of trade deteriorate)
X2
X
43
Supply Changes

• Changes in supply conditions will also shift a
  countrys offer curves around
• Examples include
• productivity changes
• discovery of new resources

44
An Example The Oil Shocks of the 1970s

• Lets think of OPEC as one country
• Lets also think of the industrial countries as
  one country
• OPEC effectively decreased its willingness to
  trade
• Presumably this shifted OPECs offer curve to the
  left, increasing OPECs terms of trade and
  decreasing the industrial countries

45
Oil Shocks of the 1970s
OCOPEC
(PX/PY)pre-shock
Other stuff
OCIC
Y1
X1
Oil
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Oil Shocks of the 1970s
OCOPEC
OCOPEC'
(PX/PY)E
Other Stuff
OCIC
Y1
X1
Oil
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Oil Shocks of the 1970s
(PX/PY)post-shock
OCOPEC
OCOPEC'
Other Stuff
(PX/PY)pre-shock
OCIC
Y1
Y2
X1
X2
Oil
48
Oil Shocks of the 1970s
(PX/PY)post-shock
OCOPEC
OCOPEC'
Other Stuff
(PX/PY)pre-shock
OCIC
Y1
Y2
OPECs terms of trade should have improved, and
the industrial countries should have worsened
X1
X2
Oil
49
Oil Shocks of the 1970s Changes in the Terms of
Trade
50
Offer Curves and Small Countries

• Small countries those that are too small to
  affect world prices (and therefore the terms of
  trade) by their own actions
• From the small countrys perspective, the
  rest-of-worlds OC is a straight line

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Small Countries and Offer Curves
OCsmall
OCROW
Y
Y1
X1
X
52
Small Countries and Offer Curves
OCsmall
OCROW
Y
Y1
Why is the ROW offer curve perceived to be a
straight line?
X1
X
53
Small Countries and Offer Curves
OCsmall
OCsmall'
Y
OCROW
Y1
If the small country imposes a tariff on ROW
products, it has no effect on the terms of trade
X1
X
54
Small Countries and Offer Curves
OCsmall
OCsmall'
Y
OCROW
Y1
If the small country imposes a tariff on ROW
products, it has no effect on the terms of
trade This is the definition of a small
country
X1
X
55
Small Countries and Offer Curves

• Q What is the optimal tariff for a small
  country?
• A No tariff at all - tariffs reduce trade
  volume, but dont improve the terms of trade
• This is really the same point we made earlier
  free trade is especially helpful to small
  developing countries