International EconomicsTenth EditionDemand and Supply, Offer Curves, and the Terms of TradeDominick SalvatoreJohn Wiley & Sons, Inc.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.CHAPTER F O U R4In this chapter:nIntroductionnThe Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium AnalysisnOffer CurvesnThe Equilibrium-Relative Commodity Price with Trade-General Equilibrium AnalysisnRelationship between General and Partial Equilibrium AnalysisSalvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.IntroductionnRelative commodity price differences between two nations in isolation reflect comparative advantage, and forms basis for mutually beneficial trade.nCan use partial and general equilibrium analysis to determine equilibrium-relative commodity price at which trade will take place.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium AnalysisnSee Figure 4-1 (next slide):nAt a relative price greater than P1, Nation 1s excess supply of X (Panel A) gives rise to Nation 1s international supply curve of X (S in Panel B).nAt a relative price lower than P3, Nation 2s excess demand for X (Panel C) gives rise to Nation 2s demand for imports of X (D in Panel B).nOnly at P2 (Panel B) does quantity of imports demanded equal quantity of exports supplied.nThus P2 is equilibrium-relative commodity price with trade.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade with Partial Equilibrium Analysis.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-2 Index of Relative U.S. Export Prices (1995 = 100).Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.Offer CurvesnOffer curves (sometimes called reciprocal demand curves) introduced to international economics by Marshall and Edgeworth.nShows how much of its import commodity a nation demands for it to be willing to supply various amounts of its export commodity.nCan be derived from production possibilities frontier, indifference map and various hypothetical relative commodity prices at which trade could take place.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-3 Derivation of the Offer Curve of Nation 1.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-4 Derivation of the Offer Curve of Nation 2.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.The Equilibrium-Relative Commodity Price with Trade-General Equilibrium AnalysisnEquilibrium-relative commodity price with trade found at intersection of offer curves for two nations.nOnly at this equilibrium price will trade be balanced.nAt any other relative commodity price, quantities of imports do not equal quantities of exports, placing pressure on relative commodity price to move toward equilibrium.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.Relationship between General and Partial Equilibrium AnalysesnBoth partial equilibrium and general equilibrium analysis use production frontiers and indifference maps to find equilibrium trade price.nOnly general equilibrium analysis considers all markets together, not just the market for commodity X.nChanges in the market for X affect other markets, which possibly impact the market for X.nGeneral equilibrium analysis is therefore required for more complete analysis.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial Equilibrium Analysis.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.The Terms of TradenTerms of trade = the ratio of the price of a nations export commodity to the price of its import commodity.nIn a two-nation world, the terms of trade of Nation 1 are equal to the reciprocal of the terms of trade of Nation 2.nIn a world of many traded goods, the terms of trade is the ratio of the export price index to the import price index, also called commodity or net barter terms of trade.nIf Nation 1 exports X and imports Y, its terms of trade are given by PX/PY, where P = price index.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.Appendix to Chapter 4 nDerivation of a Trade Indifference Curve for Nation 1nDerivation of Nation 1s Trade Indifference MapnFormal Derivation of Nation 1s Offer CurvenOutline of the Formal Derivation of Nation 2s Offer CurvenMeades General Equilibrium Trade ModelnStable and Unstable EquilibriaSalvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-7 Derivation of a Trade Indifference Curve for Nation 1.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-8 Derivation of Nation 1s Trade Indifference Map.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-9 Formal Derivation of Nation 1s Offer Curve.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-10 Outline of the Formal Derivation of Nation 2s Offer Curve.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-11 Meades General Equilibrium Trade Model.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.FIGURE 4-12 Stable and Unstable Equilibria.Salvatore: International Economics, 10th Edition 2010 John Wiley & Sons, Inc.