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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, 11th Edition © 2013 John Wiley & Sons, Inc.
Learning Goals:
 Show how the equilibrium price at which
trade takes place is determined.
 Show how the equilibrium price at which
trade takes place is determined with offer
curves.
 Explain the meaning of the terms of trade and
how they have changed over time for the
United States.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Introduction
 Relative commodity price differences
between two nations in isolation reflect
comparative advantage, and forms basis for
mutually beneficial trade.
 Can use partial and general equilibrium
analysis to determine equilibrium-relative
commodity price at which trade will take
place.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade
with Partial Equilibrium Analysis.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
The Equilibrium-Relative Commodity Price
with Trade-Partial Equilibrium Analysis
 Figure 4-1:

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, 11th Edition © 2013 John Wiley & Sons, Inc.
Offer Curves
 Offer curves (sometimes called reciprocal demand
curves) introduced to international economics by
Marshall and Edgeworth.
 Show 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, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-3 Derivation of the Offer Curve of Nation 1.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-4 Derivation of the Offer Curve of Nation 2.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
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, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Relationship between General and Partial
Equilibrium Analyses
 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, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial
Equilibrium Analysis.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
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, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 4-1 Demand, Supply, and the
International Price of Petroleum
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 4-2 The Index of Export to Import
Prices for the United States
Figure 4.2 Index of Relative U.S. Export Prices, 1972-2011
(2000=100)
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 4-3 The Terms of Trade of the G-7
Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Case Study 4-4 The Terms of Advanced and
Developing Countries
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
Appendix to Chapter 4
 Derivation of a Trade Indifference Curve for
Nation 1
 Derivation of Nation 1’s Trade Indifference Map
 Formal Derivation of Nation 1’s Offer Curve
 Outline of the Formal Derivation of Nation 2’s
Offer Curve
 Meade’s General Equilibrium Trade Model
 Stable and Unstable Equilibria
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-7 Derivation of a Trade Indifference Curve for Nation 1.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-8 Derivation of Nation 1’s Trade Indifference Map.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-9 Formal Derivation of Nation 1’s Offer Curve.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-10 Outline of the Formal Derivation of Nation 2’s
Offer Curve.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-11 Meade’s General Equilibrium Trade Model.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
FIGURE 4-12 Stable and Unstable Equilibria.
Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.
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Salvatore: International Economics, 11th Edition © 2013 John Wiley & Sons, Inc.