International Economics Tenth Edition CHAPTER F O U R 4 International Economics Tenth Edition Demand and Supply, Offer Curves, and the Terms of Trade Dominick Salvatore John Wiley & Sons, Inc. Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

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

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

See Figure 4-1 (next slide): 4.2. The Equilibrium-Relative Commodity Price with Trade-Partial Equilibrium Analysis See Figure 4-1 (next slide): At a relative price greater than P1, Nation 1’s excess supply of X (Panel A) gives rise to Nation 1’s international supply curve of X (S in Panel B). At a relative price lower than P3, Nation 2’s excess demand for X (Panel C) gives rise to Nation 2’s demand for imports of X (D in Panel B). Only at P2 (Panel B) does quantity of imports demanded equal quantity of exports supplied. Thus 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.

4.3. Offer Curves Offer curves (sometimes called reciprocal demand curves) introduced to international economics by Marshall and Edgeworth. Shows how much of its import commodity a nation demands for it to be willing to supply various amounts of its export commodity. Can 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. 4.3. Offer Curves 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.

4.4. The Equilibrium-Relative Commodity Price with Trade-General Equilibrium Analysis Equilibrium-relative commodity price with trade found at intersection of offer curves for two nations. Only at this equilibrium price will trade be balanced. At 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.

4.5. Relationship between General and Partial Equilibrium Analyses (Skip) Both partial equilibrium and general equilibrium analysis use production frontiers and indifference maps to find equilibrium trade price. Only general equilibrium analysis considers all markets together, not just the market for commodity X. Changes in the market for X affect other markets, which possibly impact the market for X. General 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.

4.6. The Terms of Trade 4.6A. Definition and Measurement of the Terms of Trade Terms of trade = the ratio of the price of a nation’s export commodity to the price of its import commodity. In a two-nation world, the terms of trade of Nation 1 are equal to the reciprocal of the terms of trade of Nation 2. In 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. If 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.

FIGURE 4-2 Index of Relative U.S. Export Prices (1995 = 100). Salvatore: International Economics, 10th Edition © 2010 John Wiley & Sons, Inc.

Case Study 4-2 (supplement) Net Barter Terms of Trade Index for Korea 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 This slide and the next contain a list of some topical issues that macro can help students understand. Feel free to substitute others as new issues emerge.