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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.

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Presentation on theme: "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."— Presentation transcript:

1 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

2 –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 = P X /P M therefore one country’s terms of trade is the inverse of the partner country’s terms of trade

3 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.

4 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.

5 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.

6 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.

7 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.

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

9 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?

10 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.

11 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.

12 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.

13 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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