International Economics
Li Yumei
Economics & Management School
of Southwest University
International Economics
Chapter 4
Demand and Supply, Offer
Curves, and the Terms of
Trade
Organization
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4.1 Introduction
4.2 The Equilibrium-Relative Commodity
Price with Trade-Partial Equilibrium Analysis
4.3 Offer Curves
4.4 The Equilibrium-Relative Commodity
Price with Trade-General Equilibrium
Analysis
4.5 Relationship between General and Partial
Equilibrium Analysis
4.6 The Terms of Trade
Chapter Summary
Exercises
4.1 Introduction
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To Develop the Simple Trade Model
Completely
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How to determine the equilibrium-relative
commodity price and terms of trade of each
nation precisely
Partial Equilibrium Analysis (utilizing demand and
supply curves)
General Equilibrium Analysis (Offer Curves)
How to determine the gains from trade are
shared by each nation
Trade Terms
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4.2 The Equilibrium-Relative
Commodity Price with Trade-Partial
Equilibrium Analysis
How the Equilibrium-relative commodity price
with trade is determined with demand and
supply curves ( with partial equilibrium
analysis)
See Figure 4.1
The Equilibrium-Relative Commodity Price with
Trade with Partial Equilibrium Analysis
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FIGURE 4-1 The Equilibrium-Relative Commodity Price with Trade
with Partial Equilibrium Analysis.
4.2 The Equilibrium-Relative
Commodity Price with Trade-Partial
Equilibrium Analysis
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Explanation of Figure 4.1
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Curves DX and SX in panels A and C of Figure 4.1 refer to the
demand and supply curves for commodity X of Nation 1 and
Nation 2 respectively. The vertical axes in all three panels
measure the relative price of commodity X. The horizontal
axes measure the quantities of commodity X.
Figure 4.1 shows that in the absence of trade, Nation 1
produces and consumes at point A at the relative price of X of
P1, while Nation 2 produces and consumes at point A’ at P3.
With the opening of trade, the relative price of X will be
between P1 and P3 if both nations are large. If the price is
above P1, Nation 1 has excess supply while Nation 2 has
excess demand when the price is below P3. Until at P2 the
quantity of imports of commodity X demanded by Nation 2
equals the quantity of exports of commodity X supplied by
Nation 1.
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4.2 The Equilibrium-Relative
Commodity Price with Trade-Partial
Equilibrium Analysis
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Partial Equilibrium Analysis
The excess supply of a commodity above the no-trade
equilibrium price gives one nation’s export supply of a
commodity. On the other hand, the excess demand of a
commodity below the no-trade equilibrium price gives the other
nation’s import demand for the commodity. The intersection of
the demand curve for imports and the supply curve for exports
of the commodity defines the partial equilibrium-relative price
and quantity of the commodity at which trade takes place.
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Case Study 4-1 and 4-2 page from 92 to 93
4.3 Offer Curves
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Origin and Definition of Offer Curves
Derivation and Shape of the Offer Curve
of Nation 1
Derivation and Shape of the Offer Curve
of Nation 2
Conclusion
 Origin and Definition of Offer Curves
In this section , first how to derive the offer curves
of the two nations and then examine the reasons for
their shape.
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Origin of Offer Curves
Offer curves were devised and introduced into international
economics by
1. Alfred Marshall (1842-1924)
2. Francis Ysidro Edgeworth (1845-1926)
Alfred Marshall (1842-1924)
Alfred Marshall was the dominant figure
in British economics (itself dominant in
world economics) from about 1890 until
his death in 1924. His specialty was
microeconomics—the study of individual
markets and industries, as opposed to
the study of the whole economy. His
most important book was Principles of
Economics. In it Marshall emphasized that the price and
Alfred Marshall (1842-1924)
output of a good are determined by both supply and demand:
the two curves are like scissor blades that intersect at
equilibrium. Modern economists trying to understand why the
price of a good changes still start by looking for factors that
may have shifted demand or supply. They owe this approach
to Marshall;
To Marshall also goes credit for the concept of price-elasticity
of demand, which quantifies buyers' sensitivity to price;
Marshall also originated the concept of consumer surplus ;
Marshall himself was born into a middle-class family in
London and raised to enter the clergy(教士). He defied his
parents' wishes and became an academic in mathematics and
economics.
Francis Ysidro Edgeworth (1845-1926)
Edgeworth was born in 1845 in
Edgeworthstown, County Longford,
Ireland into a large, Edgeworth was
educated at Edgeworthstown by tutors
until 1862, then he went on to study
languages and the classics at Trinity
College, Dublin. He proceeded in 1867 to
Oxford . it was in this 1881 book that
Edgeworth introduced into economics the generalized
utility function, U(x, y, z, ...), and drew the first
"indifference curve".
Francis Ysidro Edgeworth (1845-1926)
In 1894, he published a survey of international trade theory in
a series of articles in the Economic Journal. In it, he
pioneered the use of offer curves and community indifference
curves to illustrate its main propositions, including the
"optimum tariff".;
In 1897, he published a lengthy survey of taxation. It was here
that he articulated his famous "taxation paradox", i.e. that
taxation of a good may actually result in a decrease in price.
(See detailed introduction about Francis Ysidro Edgeworth)
 Origin and Definition of Offer Curves
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Offer curves (or Reciprocal demand curves)
The offer curve of a nation shows how much of its import
commodity the nation demands for it to be willing to supply
various amounts of its export commodity. Offer curves
incorporate elements of both demand and supply. In other
words, the offer curve of a nation shows the nation’s
willingness to import and export at various relative commodity
prices.
The offer curve of a nation can be derived from the nation’s
production frontier and indifference curve, the various
hypothetical relative commodity prices at which trade could
take place
 Derivation and Shape of the Offer Curve of
Nation 1
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Figure 4.3 Derivation of the Offer Curve of Nation1
FIGURE 4-3 Derivation of the Offer Curve of Nation 1.
 Derivation and Shape of the Offer Curve of
Nation 1
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Explanation of Figure 4.3
1. At point A no trade ( or autarky), PA=PX/PY=1/4;
2. If trade takes at point F, PF=PX/PY=1/2; Nation 1 would
exchange 40X for 20Y with Nation 2 and reach point H on its
indifference curve Ⅱ;
3. If trade takes at Point B, PB=PX/PY=1; Nation 1 would exchange
60X for 60 Y with Nation 2 and reach point E on its indifference
curve Ⅲ;
4. Offer curve of Nation 1, left panel
At different relative prices of commodity X, connecting the different
combination of exported commodity X and imported commodity Y
respectively.
 Derivation and Shape of the Offer Curve of
Nation 1
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Explanation of Nation 1’s Offer Curve Shape
Nation 1’s offer curve lies above the autarky price (1/4) and
bulges (凸出) towards the X-axis , which means the commodity of
its comparative advantage and export. ( Nation 1 export more of
commodity X, PX/PY must rise).
Why Nation 1 exports more of commodity X with the increase of
PX/PY)?
1. Nation 1 incurs increasing opportunity costs in producing more
of commodity X (for export);
2. The more of commodity Y and the less of commodity X that
Nation 1 consumes with trade, the more valuable to the nation
is a unit of X at the margin compared with a unit of Y.
 Derivation and Shape of the Offer
Curve of Nation 2
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Figure 4.4 Derivation of the Offer Curve of Nation 2
FIGURE 4-4 Derivation of the Offer Curve of Nation 2
 Derivation and Shape of the Offer Curve of
Nation 2
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Explanation of Figure 4.4
1. At point A’ no trade ( or autarky), PA=PX/PY=4;
2. If trade takes at point F’, PF=PX/PY=2; Nation 1 would
exchange 40Y for 20X with Nation 1 and reach point H’ on its
indifference curve Ⅱ;
3. If trade takes at Point B’, PB’=PX/PY=1; Nation 2 would
exchange 60Y for 60 X with Nation 1 and reach point E’ on its
indifference curve Ⅲ;
4. Offer curve of Nation 2, left panel
At different relative prices of commodity X, connecting the different
combination of exported commodity Y and imported commodity X
respectively.
 Derivation and Shape of the Offer Curve of
Nation 1
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Explanation of Nation 2’s Offer Curve Shape
Nation 1’s offer curve lies below the autarky price (4) and
bulges (凸出) towards the Y-axis , which means the commodity of
its comparative advantage and export. ( Nation 2 export more of
commodity Y, PY/PX must rise).
Why Nation 1 exports more of commodity X with the increase of
PX/PY)?
1. Nation 1 incurs increasing opportunity costs in producing more
of commodity Y (for export);
2. The more of commodity X and the less of commodity Y that
Nation 2 consumes with trade, the more valuable to the nation
is a unit of Y at the margin compared with a unit of X.
 Conclusion
The offer curve of a nation shows how much of its import
commodity the nation demands to be willing to supply various
amounts of its export commodity. The offer curve of a nation can be
derived from its production frontier, its indifference map, and the
various relative commodity prices at which trade could take place.
The offer curve of each nation bends toward the axis measuring the
commodity of its comparative advantage. The offer curves of two
nations will lie between their pre-trade, or autarky, relative
commodity prices. To induce a nation to export more of a
commodity, the relative price of the commodity must rise.
4.4 The Equilibrium-Relative
Commodity Price with
Trade-General Equilibrium Analysis
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Figure 4.5 (Page 97)
FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade
4.4 The Equilibrium-Relative
Commodity Price with
Trade-General Equilibrium Analysis
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Figure 4.5 (Page 97)
FIGURE 4-5 Equilibrium-Relative Commodity Price with Trade
4.4 The Equilibrium-Relative
Commodity Price with
Trade-General Equilibrium Analysis
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Explanation of Figure 4.5 (Page 97)
1. Trade is in equilibrium at PB. PX/PY=PB=PB’=1, Nation
1 offers 60X for 60Y (point E on Nation 1’s offer curve),
and Nation 2 offers 60Y for 60X (point E’ on Nation 2’s
offer curve), both nations happen to gain equally from
trade.
2. At any other PX/PY, trade would not be in equilibrium.
1)
2)
At any PX/PY﹤1, the quantity of exports of commodity X
supplied by Nation 1 would fall short of the quantity of imports of
commodity X demanded. This would drive the relative
commodity price up to the equilibrium level.
The opposite would be true at PX/PY﹥1
4.4 The Equilibrium-Relative
Commodity Price with
Trade-General Equilibrium Analysis
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Conclusion
The intersection of the offer curves of two nations defines
the equilibrium-relative commodity price at which trade
takes place between them. Only at this equilibrium price
will trade be balanced. At any other relative commodity
price, the desired quantities of imports and exports of the
two commodities would not be equal. This would put
pressure on the relative commodity price to move toward
its equilibrium level.
4.5 Relationship between General
and Partial Equilibrium Analysis
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Figure 4.6 (page 98)
FIGURE 4-6 Equilibrium-Relative Commodity Price with Partial
Equilibrium Analysis
4.5 Relationship between General
and Partial Equilibrium Analysis
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Explanation of Figure 4.6 (page 98)
1. S refers to Nation 1’s supply curve of exports of
commodity X; D refers to Nation 2’s demand curve for
Nation 1’s exports of commodity X;
2. D and S intersect at point E determine the equilibrium
point;
3. It shows that PX/PY﹥1 there is an excess supply of
exports of commodity X; PX/PY ﹤1 there is an excess
demand of commodity X.
4.6 The Terms of Trade
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Definition and Measurement of the Terms
of Trade
Illustration of the Terms of Trade
Usefulness of the Model
 Definition and Measurement of the Terms
of Trade
Definition
The terms of trade of a nation are defined as the ratio
of the price of its export commodity to the price of its
import commodity.
As for a two-nation world, the exports of a nation are
the imports of its trade partner, the terms of trade of the
later are equal to the inverse, or reciprocal , of the
terms of trade of the former.
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 Definition and Measurement of the Terms
of Trade
Measurement
In a world of many traded commodities, the terms of
trade of a nation are given by the ratio of the price
index of its exports to the price index of its imports. This
ratio is usually multiplied by 100 in order to express the
terms of trade in percentage.
These terms of trade are often referred to as the
commodity or net barter terms of trade to distinguish them
from other measures of the terms of trade presented in
Chapter 11 in connection with trade and development.
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 Definition and Measurement of the Terms
of Trade
1. Trade improvement
An improvement in a nation’s terms of trade is usually regarded
as beneficial to the nation in the sense that the prices that the
nation receives for its exports rise relative to the prices that it
pays for imports.
2. Trade deterioration
An deterioration in a nation’s terms of trade is usually regarded
as harmful to the nation in the sense that the prices that the
nation receives for its exports decrease relative to the prices that
it pays for imports.
 Illustration of the Terms of Trade
Nation 1 exports commodity X and imports
commodity Y, the terms of trade of Nation 1 are
given by PX/PY (When PX/PY=1means 100
percentages)
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Nation 2 exports commodity Y and imports
commodity X, the terms of trade of Nation 2 are
given by PY/PX
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One Nation’s terms of trade improves means its
trading partner’s terms of trade deteriorates. (e.g.
the middle page 100)
Case study 4-3 and 4-4 from page 101 to 102
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 Usefulness of the Model
General Equilibrium Model
It shows the conditions of production, supply, in the two nations,
the tastes, or demand preferences, the autarky point of production
and consumption, the equilibrium-relative commodity price in the
absence of trade, and the comparative advantage of each nation;
It also shows the degree of specialization in production with trade,
the volume of trade, the terms of trade, the gains from trade, and
the share of these gains going to each of the trading nations.
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The Further Extension of the Trade Model
To identify the basis for comparative advantage;
To examine the effect of international trade on the returns, or
earnings, of resources or factors of production in the two trading
nations.
Chapter Summary
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In this chapter by using the offer curve of a nation
the trade equilibrium point can be clearly and
precisely determined.
To further the trade model as a completely general
equilibrium model. It can be used to examine how
a change in demand and or supply conditions in a
nation would affect the terms of trade, the volume
of trade, and the share of the gains from trade in
each nation ( this is done in chapter 7)
Limitations: to identify the basis for comparative
advantages; to examine the returns or earnings of
resources or factors of production
Exercises
Discussion Questions:
Page 105 from 1 to 13 questions
Exercises
Additional Reading
An excellent discussion of offer curves is found in:
 A.P.Lerner, “The Diagrammatic Representation of Demand
Conditions in International Trade,” Economica, 1934, pp.319334
 G. Haberler, The Theory of International Trade (London:W.
Hodge & Co., 1936), ch.11
For the law of reciprocal demand, see:
 J.S.Mill, Principle of Political Economy (New York: Kelly, 1965,
a reprint of Mill’s 1848 treatise ) , ch.18
Internet Materials
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http://www.imf.org
http://www.eia.doe.gov