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 country’s
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 country’s
willingness to trade
– The effects of shifts in a country’s willingness
to trade depends on the import-demand
elasticity of the partner country
– Greater demand for a country’s exports CAN
lead to a decrease in exports if the exporting
country has inelastic demand for the partner
country’s imports
– Growth that leads to a greater willingness to
trade CAN lead to a deterioration in the
country’s terms of trade IF the partner country
has inelastic demand for imports from the
growing country
– NOTE: Terms of trade = PX/PM therefore one
country’s terms of trade is the inverse of the
partner country’s terms of trade
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 country’s
exports on the horizontal axis and imports
on the vertical axis.
• We draw a line through the points.
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.
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 country’s offer curve.
• 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.
• 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.
• Equilibrium is found at the relative price for
the two goods where each is willing to
purchase what the other wants to sell.
• If a country’s 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?
• 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.
Implications of import elasiticities
• If a country FACES inelastic demand for its
exports (the partner country, or the world’s
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.
• 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.
• 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