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Chapter 2
How is TOT established Mill’s Reciprocal Demand Principle
Graph Autarky Trade equilibrium
Offer Curve Conception How to derive offer curve Trade equilibrium
Chapter 2
Offer Curves are all combinations of a country’s
desired exports and imports at different terms of trade
also known as reciprocal demand curves (J.S. Mills)
measures of willingness to trade
Chapter 2
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
Chapter 2
Deriving Country B’s Offer Curve This will reflect Country B’s
willingness to trade at different terms of trade
B’s offer curve bows towards the axis with B’s import good on it
Chapter 2
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
Chapter 2
Terms of Trade EquilibriumY
X
(PX/PY)E
X1
Y1
OCA
OCB
If these are the terms of trade,country A will desire to exportX1 units, and country B will want to import X1 units;
country A will desire to importY1 units, and country B will want to export Y1 units
Chapter 2
How Do We Know It’s 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
Chapter 2
Disequilibrium
Y
X
(PX/PY)1OCA
OCBY1
Y2
At (PX/PY)1, country A wishesto import Y1 units, but country B is only interested in exporting Y2
units. That is, there is an excess demand for good Y.
Chapter 2
Disequilibrium
Y
X
(PX/PY)1OCA
OCB
X1X2
At (PX/PY)1, country A wishesto export X1 units, but country B is only interested in importing X2
units. That is, there is an excess supply of good X.
Chapter 2
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
Chapter 2
Disequilibrium Terms of trade lines that are flatter
than (PX/PY)E, such as
Y
X
(PX/PY)2OCA
OCB
Chapter 2
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