1. Copyright ©2004, South-Western College Publishing International Economics By Robert J. Carbaugh 9th Edition Chapter 3 (B): Sources of Comparative Advantage

2. Carbaugh, Chap. 3 2 Indifference curves  Final pattern of trade depends not just on supply, but also on demand - which is determined by income & individual tastes  Tastes can be shown graphically with indifference curves, which show the various combinations of two goods that give a consumer the same total level of satisfaction Bringing demand into the model

3. Carbaugh, Chap. 3 3 A consumer’s indifference map Bringing demand into the model

4. Carbaugh, Chap. 3 4 Indifference curves (cont’d)  Indifference curves have a negative slope  Keeping satisfaction constant means giving up some of one good for more of another  Indifference curves are convex  As the consumer gets more of one good, she is less willing to give up what is left of the other  The rate of substituting one good for another is shown by the slope of the curve, the marginal rate of substitution Bringing demand into the model

5. Carbaugh, Chap. 3 5 Indifference curves (cont’d)  “Higher” indifference curves (those farther from the origin) represent greater levels of satisfaction  Individual preferences cannot really be added up into a “community indifference curve” but it is useful to imagine that they can for the purposes of trade theory Bringing demand into the model

6. Carbaugh, Chap. 3 6 Indifference curves and int’l. trade Bringing demand into the model

7. Carbaugh, Chap. 3 7 Basis for trade, gains from trade Bringing demand into the model

8. Carbaugh, Chap. 3 8 Equilibrium terms-of-trade limits International equilibrium

9. Carbaugh, Chap. 3 9 Theory of Reciprocal Demand (Mill)  Actual trading prices depend on the interaction of trading partners’ demands  Final terms of trade will be closer to the domestic price ratio of the nation with stronger demand for the imported good  Applies to nations of equal economic size, which will share gains nearly equally  Small nations trading with large ones can receive the bulk of the gains from trade International equilibrium

10. Carbaugh, Chap. 3 10 Offer curves: supply and demand International equilibrium

11. Carbaugh, Chap. 3 11 Offer curves: supply and demand International equilibrium

12. Carbaugh, Chap. 3 12 Equilibrium terms of trade International equilibrium

13. Carbaugh, Chap. 3 13 Changing equilibrium terms of trade International equilibrium

14. Carbaugh, Chap. 3 14 Immiserizing growth Impact of trade