1. How is TOT established Mill’s Reciprocal Demand Principle Graph
Autarky
Trade equilibrium
Offer Curve
Conception
How to derive offer curve

2. Autarky
Price Line Y A K I2 Y0 I1 I0 O X0 B X

3. Trade Equilibrium

4. Offer Curves are
all combinations of a country’s desired exports and imports at different terms of trade
also known as reciprocal demand curves (J.S. Mills)
measures of willingness to trade

5. Y C P Y1 Y2
(PX/PY)1 Y X1 X2 X
(PX/PY)1 Y5 X5 X

6. Y Y3
(PX/PY)1 Y4
(PX/PY)2 X3 X4 Y X
(PX/PY)2
(PX/PY)1 Y6 Y5 X5 X6 X

7. Y Y3
(PX/PY)1 Y4
(PX/PY)2 X3 X4 Y X
OCA
(PX/PY)2
(PX/PY)1 Y6 Y5 X5 X6 X

8. Offer Curves
Offer curves represent willingness to trade at every possible terms of trade
As the relative price of good X rises, Country A becomes willing to export more and import more
Offer curves “bow” towards the import good axis

9. Deriving Country B’s Offer Curve
This will reflect Country B’s willingness to trade at different terms of trade
B’s offer curve bows towards the axis with B’s import good on it

10. Y
(PX/PY)1 p Y7 c Y8 Y X7 X8 X
(PX/PY)1 Y9 X9 X

11. Y
(PX/PY)1
Y10
(PX/PY)2
Y11 Y
X10
X11 X
(PX/PY)1
(PX/PY)2
OCB
Y12 Y9 X9
X12 X

12. Terms of Trade Equilibrium
The international terms of trade (that is, PX/PY) will be the slope of a line passing through the point where the offer curves cross.
This equilibrium point takes into account demand and supply conditions in both countries

13. Terms of Trade EquilibriumY X
(PX/PY)E X1 Y1
OCA
OCB
If these are the terms of trade,
country A will desire to export
X1 units, and country B will
want to import X1 units;
country A will desire to import
Y1 units, and country B will
want to export Y1 units

14. How Do We Know It’s Equilibrium?
Any terms of trade other than (PX/PY)E will result in
excess demand for one good
excess supply for the other
Therefore relative prices will adjust until (PX/PY)E is reached

15. Disequilibrium OCA (PX/PY)1 Y Y1 OCB At (PX/PY)1, country A wishes
to import Y1 units, but country B
is only interested in exporting Y2
units. That is, there is an excess
demand for good Y.

16. Disequilibrium OCA (PX/PY)1 Y OCB At (PX/PY)1, country A wishes
to export X1 units, but country B
is only interested in importing X2
units. That is, there is an excess
supply of good X.

17. Disequilibrium Excess demand for Y causes PY to rise
Excess supply of X causes PX to fall
Thus, (PX/PY) falls
In other words, the terms of trade line gets flatter, moving the countries in the direction of equilibrium

18. Moving Towards EquilibriumY X
(PX/PY)1
OCA
OCB

19. Disequilibrium
Terms of trade lines that are flatter than (PX/PY)E, such as Y X
(PX/PY)2
OCA
OCB

20. Disequilibrium
Terms of trade lines that are flatter than (PX/PY)E will results in
an excess demand for good X
an excess supply of good Y, and so
(PX/PY) will rise
That is, the terms of trade line will get steeper until (PX/PY)E is reached

21. Moving Towards Equilibrium
OCA Y X
(PX/PY)2
OCB