Offer Curves and terms of trade

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Offer Curves and terms of trade

• Important points for this chapter
• If two LARGE countries are trading, then the
  terms of trade are determined by each countrys
  willingness to trade at a particular price ratio.
• If a country increases demand for imports, this
  is always accompanied by an increase in
  willingness to supply exports to purchase those
  imports.
• Therefore, an increase in demand for imports, or
  an increase in supply of exports can be
  summarized as an increase in a countrys
  willingness to trade

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• The effects of shifts in a countrys willingness
  to trade depends on the import-demand elasticity
  of the partner country
• Greater demand for a countrys exports CAN lead
  to a decrease in exports if the exporting country
  has inelastic demand for the partner countrys
  imports
• Growth that leads to a greater willingness to
  trade CAN lead to a deterioration in the
  countrys terms of trade IF the partner country
  has inelastic demand for imports from the growing
  country
• NOTE Terms of trade PX/PM therefore one
  countrys terms of trade is the inverse of the
  partner countrys terms of trade

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How we derive an offer curve

• We start with one country, we examine how much it
  wants to export and import at different price
  ratios (Px/Pm)
• We plot a number of these points on a separate
  graph that has the countrys exports on the
  horizontal axis and imports on the vertical axis.
• We draw a line through the points.

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Two price ratios, two export-import combinations
The relative price of X rises from figure A to
figure B. The country is willing to export more
X and import more Y in figure B The offer curve
summarizes each of these export-import
combinations for all relative prices.
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• Map the price changes to draw the offer curve.
• The level of exports for each of the previous
  price ratios is measured on the horizontal axis,
  imports on the vertical.
• As the price changes, we can draw a line through
  these points to get the countrys offer curve.

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• The offer curve for a 2nd country is found in the
  same way.
• Here we see how the offer curve for country 1
  would appear if X were on the vertical axis and Y
  on the horizontal axis.

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• This is the offer curve for a 2nd country that
  exports Y and imports X. You can see that this
  curve is found in the same way as the offer
  curve for country 1.

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• Equilibrium is found at the relative price for
  the two goods where each is willing to purchase
  what the other wants to sell.

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• If a countrys productive capacity or its tastes
  change, it may become more or less willing to
  trade at all price ratios
• Can you suggest possible causes for a shift in
  the offer curve?

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• The slope of the offer curve reflects the
  elasticity of demand for imports.
• The import elasticity can be measured by 0R/0S.
• In the first last figure, the import elasticity
  is less than 1.

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Implications of import elasiticities

• If a country FACES inelastic demand for its
  exports (the partner country, or the worlds
  import elasticity is less than 1), then the
  country can lose access to imports from growth
• Ex A country exports wheat. The demand for
  wheat is inelastic. The country grows, produces
  more wheat. Instead of earning more revenue, the
  terms of trade deteriorate, and the country can
  buy fewer imports than before it increased its
  output of wheat.

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• Here, an increase in the price of X leads country
  1 to buy MORE imports from country 2, but uses
  fewer exports to purchase the imports. Country 2
  faces inelastic demand for good Y.

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• Country II becomes more willing to trade through
  growth, but the effect is to lower its ability to
  import X, even though it is exporting more of
  good Y to country I

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